BREXIT- Hand-over your contingency plans…

Crossing out Plan A and writing Plan B on a blackboard.

Earlier this month the Bank of England’s Prudential Regulation Authority (the ‘PRA’) wrote to all UK companies undertaking cross-border activities between the UK and the EU under passporting arrangements, requesting a summary of their Brexit contingency plans.

The letter continues the regulator’s focus on ensuring firms have robust measures and business strategies in place to respond to market turbulence.  Addressed to the CEO/Branch Manager of each company, the letter states that firms are expected to create concrete contingency plans for a variety of potential scenarios (given the wide range of possible outcomes), in light of the UK Government’s decision to trigger Article 50.  This is to ensure the safety and soundness of each company’s UK operation, and to mitigate any risk of adverse financial consequences through effective structural planning e.g. setting up a subsidiary.

Interestingly, the PRA stated that although it was aware that many of its firms were well-advanced in their Brexit planning, the adequacy of these plans appeared uneven across companies, with many not being sufficiently tested against the most adverse outcomes.  It further stated that the responses submitted by firms would be used to shape the Bank’s own plans.

The letter highlights the need for UK companies to face the physical reality of Brexit and it will be interesting to see the types of contingency plans that emerge as a result.

The Prime Minister’s decision on Tuesday to call a snap General Election will not make this task any easier, at least in the short term, as the ‘hardness’ or ‘softness’ of Brexit is once again up for grabs.

For further information please see a copy of the letter here.

Indemnities – beware the consequences of “reasonableness”

Blog - reasonableThe provision of indemnities, particularly those provided to corporate trustees and agents, is an important feature of an effectively functioning structured finance market.  It enables the parties involved to allocate the risks of unforeseen expenditure to those parties with the ultimate economic interest in the transaction and allows trustees and agents to keep their fees at a reasonable level.

Whilst the need for indemnities is generally accepted, the terms on which they are provided can be an area of robust negotiation.

A recent case in the Commercial Court has highlighted the importance of carefully drafted indemnities, in a ruling which focused on the consequences of limiting attorney fees for which a party may recover under an indemnity to “reasonable attorney fees”.

In the case, the Claimant, Euro-Asian Oil SA, contended that, as it had a letter of indemnity in place with the Defendant, Credit Suisse AG, it should be entitled to recover its legal costs in connection with a dispute, on an indemnity basis.  The Commercial Court however held that the Claimant could only recover its costs on the standard basis, as the letter of indemnity included a limitation as to the recovery of “reasonable attorney fees”.

Specifically, the letter of indemnity provided that the Defendant would “protect, indemnify and to hold you [the Claimant] harmless from and against any and all damages, costs and expenses (including reasonable attorney fees) which you [the Claimant] may suffer by reason of the shipping documents…”.  Claimant’s counsel argued that the court should give effect to the parties’ contractual agreement regarding attorney’s fees and that the word ‘including’ was expansive and non-restrictive, meaning that, taking this into account with the provision for payment of ‘any and all cost and expenses’, the indemnity should be construed as a contractual basis for indemnity costs to be awarded.

Cranston J. disagreed, first distinguishing this case from the authority relied upon by the Claimant as the indemnity in that case did not include a limitation to “reasonable attorney fees”, and, secondly, concluding that the result of the inclusion of the phrase “reasonable attorney fees” resulted in the contract not providing for indemnity costs “because they would not be reasonable”. Consequently, the Claimant’s contractual right to costs was confined to costs on a standard basis.

To grasp the import of this, a brief refresher on costs may be helpful.

In general, there are three ways such costs can be recovered.  First, following a clear contractual agreement (e.g. indemnity) the indemnifying party shall simply pay fees pursuant to the contract. However, if there is no such agreement or if such an agreement is unclear or the amount is disputed, separate legal proceedings will be required to determine how the costs of the dispute are to be borne. Where costs proceedings are initiated, the court will make its costs order on either the standard basis or on the indemnity basis.

When dealing with costs awarded in litigation, there is a presumption that costs will be assessed on the standard basis (the most common approach used by the Courts) and under it a judge will only allow the recovery of costs where they are proportionate, and either reasonably incurred or reasonable in amount. If there is any doubt about either the reasonableness or proportionality, the judge will give the paying party the benefit of that doubt.

However, in circumstances where, for example, a party’s conduct during the proceedings is found to have been egregious, the other party may request that the court makes its order for costs using the “indemnity basis”.  If the court agrees to make a costs order on this basis, there is no requirement that the costs incurred are proportionate and costs will only not be recoverable if the paying party is able to show that they have been unreasonably incurred or are unreasonable in amount.

In deciding any dispute as to the amount of costs payable pursuant to a contractual indemnity, the starting point will usually be that the costs payable under those contractual terms will be presumed to be reasonably incurred and reasonable in amount.  This is akin to an award of costs on the indemnity basis and might well result in the indemnified party recovering in full.  However, as the decision in the Euro-Asian Oil case emphasises, this is not guaranteed and the precise wording of the indemnity will be important.  In the Euro-Asian Oil case, for example, as explained above, the judge found that it would not be appropriate to award indemnity costs pursuant to a contractual indemnity for “reasonable attorney’s fees” because indemnity costs are not “reasonable”.  Therefore, the judge decided that the award would be for costs on a standard basis.

So, the result of the indemnity including the phrase “(including reasonable attorney fees)” can have significant consequences on the recoverability of costs.  If there is a dispute over the amount payable pursuant to an indemnity for “reasonable fees”, the indemnified party might be put to the test of proving that the costs claimed are reasonable and proportionate.  This may result in a far smaller recovery than would have been the case if the word “reasonable” had not been in the indemnity.

This serves as a reminder of the importance of focussing on the terms of any transaction indemnity and explains indemnified parties’ resistance to the inclusion of reasonableness qualifiers in their indemnities.

ESMA clarifies timelines for publication of credit ratings and rating outlooks

ESMA for blogCredit rating agencies (‘CRAs’) that operate in the EU will be interested to hear that on 30 March 2017, ESMA published an update to its Questions & Answers (Q&A) on the ‘CRA’ Regulation (Regulation 1060/2009, as amended in 2011 and 2013).  The CRA Regulation requires CRAs within the EU to be registered and to comply with requirements relating to their independence and avoidance of conflicts of interest, their methodologies, their disclosures and their approach to sovereign debt.  It also contains requirements on parties involved in securitisations in respect of the rating of structured finance instruments.

Further guidance on Article 10 of the CRA Regulation (covering Disclosure and Presentation of Credit Ratings) has been provided by way of an additional section to the Q&As, which can be found here.

The guidance will ensure that CRAs and rated entities are clear as to their roles and responsibilities under this provision by specifically confirming how much time a CRA should provide to a rated entity prior to the publication of a credit rating or rating outlook: 24 hours, at a minimum.  It will also protect investors by ensuring the timely publication of credit ratings and rating outlooks “without delay”.

Fairhold Securitisation – can noteholders claim advisers’ fees through the trustee?

This week saw the High Court clash between the swap provider, UBS, and the recently appointed replacement note trustee (Glas Trust Corporation) on the embattled Fairhold Securitisation.  The dispute at hand centres on whether or not the ad hoc noteholders group’s fees and expenses (comprising the fees of its financial adviser and lawyers) can be recovered from the waterfall, effectively subordinating payments to the swap providers and noteholders.  The financial adviser’s fees were reported to be in excess of £3.75m.

Followers of the Fairhold Securitisation saga will be aware of the wider dispute between noteholders and the swap providers, in which noteholders directed the note issuer to rescind the transaction’s swaps, on the basis that the note issuer was induced to enter into the swaps as a result of an alleged fraudulent misrepresentation made by swap providers.

Whilst the two day hearing on the advisory fees dispute has now concluded, judgement has been reserved, so a further update will be posted on this blog once judgement has been handed down.  The outcome will be particularly relevant for corporate trustees, investors, financial advisers and lawyers advising in the context of capital markets restructurings and disputes.

Class X litigation: Not so appealing

Following their loss at first instance in Titan Europe 2006-1 P.L.C. and others [2016] EWHC 969 (Ch) (the background to the case and our commentary can be found here), the Class X Noteholder appealed the decision in respect of the central issue in the proceedings –  when calculating the Class X Interest Rate in accordance with the Conditions, is it necessary to take account of any additional interest due under the Loans following a default? A victory for the Class X Noteholder would likely mean a substantial pay out to them over the four CMBS transactions. However, once again, the English Courts have ruled against them on the issue. In a split decision, the Court of Appeal in Credit Suisse Asset Management LLC v Titan Europe 2006-1 PLC & Ors [2016] EWCA Civ 1293 dismissed the appeal, stating (per Arden LJ) that:

In summary, I conclude that the “per annum interest rate” in the definition in the Ts & Cs of “Net Mortgage Rate” is the ordinary rate of interest payable on the underlying loans exclusive of any element of default interest. So default interest payable on the underlying loans is not to be taken into account in calculating the Class X Interest Rate. There was also commercial logic in excluding default interest.”

That conclusion was supported by Underhill LJ, who stated “I agree with Arden LJ that the phrase “per annum interest rate”, in the context in which it appears, most naturally reads as a reference to the ordinary interest rate applicable to the Loans and specified in the Offering Circular”.

In contrast, Briggs LJ reached the opposite conclusion on the construction of the relevant drafting and stated “I regard the natural meaning, in its context, of the critical phrase “the related per annum interest rate due on such Loan” as meaning the per annum rate which includes all the interest contractually due as at the relevant Payment Date under the relevant loan agreement, so that it includes what may loosely be called default interest whenever that is, or is part of, the interest rate due as at that date.  Although that outcome produces a result in the context of a serious default which bears harshly on noteholders lower in the waterfall than the Class X noteholders, that factor is insufficient to require the critical phrase to be given some restricted meaning contrary to its contextual meaning.”

Reed Smith represented the successful Issuers in each transaction. The full judgment can be found here

It is of course open to the Class X Noteholder to make an application for permission to appeal to the Supreme Court. Watch out 2017…

CMBS noteholder litigation: where do they stand?

The recent spate of litigation in CMBS transactions by noteholders to obtain interpretations of their rights directly in the English courts rather than through the note trustee raises two distinct questions: do investors have standing as a matter of both the transaction documents and general contract law to launch such proceedings and secondly should they be able to?

A typical limited recourse CMBS transaction will contain a general restriction on noteholders proceedings directly against the issuer to enforce their rights under the transaction documents (that right being reserved for the note trustee). On its face that should prohibit noteholders launching proceedings where the issuer is named as a defendant. However, depending on the wording of the clause on question, it could be argued that proceedings launched under Part 8 of the Civil Procedure Rules (“Part 8 Proceedings”) which are aimed at resolving matters of interpretation are not caught by such restrictions even if the issuer in such proceedings is technically listed as a defendant.

At law the situation is slightly different, in a global note structure an investor will hold their entitlement through the clearing systems (and related intermediaries) and while we refer to such investors as ‘noteholders’ in the colloquial sense (as such persons will be beneficially entitled to a proportion of the interest and principal paid by an issuer) they do not have a direct contractual relationship with the issuer. The actual ‘noteholder’, as a matter of contract law, is the holder of the global note and without direct rights being granted to the ultimate investors in the issuance (e.g. through additional deeds of covenant or drafting in the transaction documents), such investors will not arguably have the locus standi required to launch proceedings against as issuer (as they are not a party to the relevant contracts). In order to get around this restriction, the English courts would have to look through the global note structure and grant direct rights to the ultimate investors. The courts have been reluctant to do so and have adopted a ‘no look through’ principle (as recently affirmed, although not in a CMBS transaction, in Secure Capital SA v Credit Suisse AG [2015] EWHC 388 (Comm)) in relation to notes held in the clearing systems.

The second question is whether the ultimate investors should be able to launch Part 8 Proceedings in order to interpret certain provisions of the transaction documents. There is, of course, an advantage in achieving certainty of interpretation when it comes to ambiguous provisions of the documents and should a genuine ambiguity in interpretation arise, it is open for the relevant transaction parties to agree that it would be sensible for a noteholder to lead and indeed launch Part 8 Proceedings (rather than having a note trustee front their position). However, the obvious danger in allowing any and all ultimate investors to launch such proceedings without the consent of the other transaction parties is that multiple proceedings could be launched either simultaneously or consecutively significantly increasing the costs of the transaction and ultimately impacting junior noteholder recoveries. In addition, without the ability of the note trustee to ‘filter’ investor concerns and allegations, the process is open to abuse as investors could launch Part 8 Proceedings which do not purely deal with matters of interpretation but seek to obtain access to additional information and/or involve disputes of fact. In such circumstances, the issuance of Part 8 Proceedings would likely be disputed by the transaction parties but that in itself will come at a cost to the transaction. As in most cases, the drafting of in the individual clauses will be key. Better start reading those terms and conditions closely…

Happy Holidays all!

Italian NPL Market: the tightrope walker and the seagull!

During the summer I wrote about the marvels of the Italian tightrope trick (The NPL Circus: the Italian Tightrope) and remarked on the massive feat of the Italian legislature in making the seemingly impossible, possible with the establishment of a state guaranteed securitisation structure that is capable of divesting a significant volume of non-performing loans (NPLs) without “bailing in” creditors.

With the news that Prime Minister Matteo Renzi had failed to secure a victory for his “yes” campaign, there will now be a fresh challenge for the Italian NPL market.  It is as if a seagull has just dive bombed the Italian tightrope walker, the consequence being a stomach churning wobble or maybe a slip.  Although the arrival of this unwelcome guest is rightfully going to be treated by the tightrope walker with disdain, nevertheless the audience should not be surprised ‎as it may be that this is very much part of the trick.

The reality is that the beleaguered Italian banks continue to have astronomical volumes of NPLs that must be off-loaded in order to strengthen the banks and make them more resilient.  Nobody said that it would be easy and nor should it be given the complexity of the Italian banking system and the fact that Italian domestic retail investors are so heavily entwined with the banks.  By devising the guarantee securitisation structure, the Italian legislature has not only demonstrated that the deleveraging of the banks is a political “must” but that it is willing to implement the necessary legislation required to ensure that the Italian banks fulfil these political aims.

It is fair to say that the results of the Italian referendum and the subsequent resignation of Mr Renzi will no doubt be treated with trepidation given the obvious political uncertainty this creates.  However, one thing that does remain certain (and despite the fact that it is a magical time of the year) is that these huge volumes of NPLs are not going to miraculously disappear nor can they just be swept under the carpet.  In fact, when it comes to considering the deleveraging of the Italian banks, one cannot help but be reminded of the expression “too big to fail” that was so frequently used at the beginning of the global financial crisis when considering the status of banks.  The same can also be said of the Italian deleveraging process: it really is too big to fail (without exception) as the off-loading of NPL’s is integral for rehabilitating the banks and therefore the Italian economy as a whole.  It is for this reason indeed, that yesterday’s vote should merely be regarded as a wobble and very much part and parcel of the excitement and drama of the trick.

With-Hold on a second?! New ISE rule leads to automatic de-listing of debt securities at scheduled maturity

Picture this: it’s 1793. In England, George III is on the throne and the Bank of England issues the first ever ‘fiver’.  In the U.S.A, George Washington hosts the first US cabinet meeting as President and the capital moves from Philadelphia to Washington, D.C.  In France, the French Revolution is in full swing with King Louis XVI guillotined, and France becomes the first country to adopt the metric system.

And in Ireland, the Irish Stock Exchange is founded. Though of course, that is not to say that there weren’t other important things happening in Ireland at the time as well…. Continue Reading

The NPL Circus: the Italian Tightrope

This summer, fans of the non-performing loan (NPL) circus, are in for a treat with the launch of the Italian tightrope trick.

Spurred on by the recent European Banking Authority stress tests, the news last week that Banca Popolare di Bari will become the first bank to utilise the Italian state guarantee scheme and deploy securitisation technology as a means of off-loading a €470m portfolio of non-performing loans is a significant step forward for the global NPL market and therefore the NPL circus.

As we noted in April (Italian reform and the latent potential for CMBS), Italy is certainly the jurisdiction to watch in 2016 and in that vein, we are pleased to see that after months of waiting, the first Italian NPL securitisation will be deployed as a mechanism to address Italian bank NPL anguish. Although the application of this technology could be a huge boost for both the European NPL market and the utilisation of securitisation technology, the realities of whether this will become a commercial success will ultimately be contingent on the pricing of notes. Assuming, that these commercial objectives can be met (and there is every chance that they will be, given that the capital markets are currently awash with low yielding paper) then this is likely to be the first of many deals from the beleaguered Italian market and with it the NPL circus will have a new trick.

The establishment of this structure will be a massive feat for Italy, as somehow the Italian legislature has managed to conjure the impossible: on the one hand they have been prevented from applying state aid to address the NPL issue without “bailing in” creditors yet on the other hand the “bailing in” of creditors has not been a viable option given that these largely comprise Italian retail investors. In other words by devising a state guaranteed securitisation structure that is capable of divesting a significant volume of NPL’s, the Italians have somehow proven that it is metaphorically possible for someone to walk along a tightrope with their arms tied firmly behind their back and a parrot stood on their shoulder for good measure!

Although admittedly it has taken a while for the first transaction to reach fruition, the fact that Italy has proven that the seemingly impossible is possible, in a world where there is ever increasing focus on those banks that possess sizeable NPL exposures, then it is quite conceivable that from the doldrums of banking woes, Italy has managed to prove that there is a glimmer of hope for those banks and jurisdictions currently  struggling under the weight of their NPL’s.

As for the NPL circus, it is fantastic news that finally we can watch the long awaited Italian tightrope trick, however as the audience watch with bated breath, we cannot help but think, is this is a one trick wonder or a regular addition to the show!


Brexit – what can private equity funds do to hedge against sterling risk?

We have seen a dramatic increase in interest in hedging FX risk related to investments by private equity funds.

The precipitous decline in the value of sterling has caused complications for funds which are in the process of acquiring UK assets. For deals which are still going ahead, many sponsors are using or considering deal contingent FX hedges to protect them against further fluctuations. These products are offered by a small number of banks to funds which are buying or selling assets denominated in a different currency to their base currency.

They allow the fund to enter into an FX forward which will only settle if the sale goes ahead (for example, when the conditions precedent to completion such as competition clearance are satisfied). The forward agreement includes a schedule of settlement dates with FX rates which gradually move against the fund depending on when settlement actually occurs. They are, in a sense, options without a premium which are contingent on completion.