As outlined in our previous blog, X-tra, X-tra, Real All About It! published on Friday 8 April, Mr Justice Snowden handed down judgment of the High Court in the much anticipated Windermere VII Class X Notes dispute.

The Dispute

This was a dispute concerning the €782,200,000 Windermere VII pan-European CMBS transaction in which the holder of the Class X Notes and a holder of the Class B Notes commenced proceedings in the English High Court seeking a number of declarations as to the proper construction of the transaction documents.

Broadly speaking, these declarations relate to the basis on which payments of Class X interest had been made on the payment dates in January and October 2015 and whether there had been an underpayment of Class X interest, whether any such underpayment constitutes an Event of Default and whether or not any unpaid amount accrues interest at the Class X Interest Rate.  This involved considering of the application of the intercreditor agreements, and the effect of capitalisation of unpaid interest on the Class X noteholder’s entitlement.

The Class X noteholder alleged that there had been a miscalculation and underpayment of Class X interest, an Event of Default on the Notes as a result and that the unpaid Class X interest accrued interest at the Class X interest rate, which had been as much as 6,001%. This could have led to claims for substantial amounts that would be have had a material impact on the recoveries of other noteholders in the structure.

As the claimants also held over 25% of the now most senior Class B Notes, it was apparent that if an Event of Default had occurred, it would entitle them to invoke the post-enforcement priority of payments, under which the Class X noteholder could seek to be paid from both principal and interest collections on the Loans rather than from interest collections only (as is the case prior to enforcement).  Given the extremely high Class X Interest rates and the contention that any unpaid amounts accrue interest at that rate, it was not inconceivable that if they were successful on their arguments, the Class X noteholder would stake a claim to all remaining Loan proceeds in the transaction and leave other noteholders with nothing.

The Judgment

However, after hearing the arguments, Mr Justice Snowden disagreed with the Class X noteholder and found in favour of the Issuer and the other defendants on all points:

I do not consider that there has been an underpayment of the Class X Interest Amount for the January 2015 or October 2015 Payment Dates, or that any further interest at the Class X Interest Rate would have accrued thereon under Condition 5(i), or that any Note Event of Default has occurred as a consequence.”

The full judgment can be found here.

Points of Interest

The reasoning in the judgment provides some useful insight and guidance for structured finance professionals and will be of particular interest to noteholders and transaction parties on other legacy and newly issued CMBS transactions. As a result, we will go through some of the points in more detail.

Correction by Construction or Implication:

Mr Justice Snowden reconfirmed that the test for correcting a contract by construction or the implication of a term were strict.  He held that:

The test that must be satisfied to justify [the correction by construction or implication of a term] is a strict one.  The court will not supply additional words or terms simply because it is reasonable to do so in the circumstances that have arisen.  The court will only add words to the express terms of an agreement if it is necessary to do so because the agreement is incomplete or commercially incoherent without them.  Even then, the court must be certain both that the absence of the missing words was inadvertent, and that if the omission had been drawn to the attention of the parties at the time of contracting they would have agreed what additional provision should be made

As a matter of construction, it is also important to note that the test was being applied at the time the documents were entered into without the benefit of hindsight.

In this case, the strict test was not satisfied because:

  • The relevant provisions which the claimants had sought to correct were important provisions that the parties would have specifically negotiated; they were not boilerplate;
  • There was a presumption that the court does not “readily accept that people have made mistakes in formal documents” and there was no basis to conclude that the parties might have failed to foresee the situation that arose that the claimants contended had not been dealt with by the documentation;
  • The proposed correction proffered by the claimants did not accurately cure the problem that it contends has arisen; and
  • It was impossible to determine that the parties would certainly have adopted the proposed language and ultimately, this uncertainty was ‘fatal’ to the test for correction by construction or implication

One clause that was specifically referred to in the Issuer’s defence was a general provision governing what would occur if unforeseen events were to arise that weren’t dealt with in the documents.  In this case, the ‘sweeper’ clause was a provision that authorised the Agent to act on instructions from the Majority Senior Lenders or otherwise act in what the Agent determined to be in the best interests of the Lenders.  Mr Justice Snowden confirmed it was preferable to rely on this more general ‘sweeper’ clause than rely on the words suggested by the claimant.  It might be that including more general ‘sweeper’ clauses to cover what might happen in unforeseen circumstances could make it rather difficult for successful arguments to be made that something has actually gone wrong in the documentation on the basis that the current language does not specifically deal with events that have not occurred but might realistically have occurred.

Interest on unpaid Class X Interest?

Despite the fact that Mr Justice Snowden had already determined that the strict tests of ‘correction by construction’ and ‘implication’ had not been satisfied and therefore that there were no underpayments of Class X Interest, he nevertheless went on to consider the other questions that would have arisen had he decided that Class X interest had been incorrectly calculated; in particular whether any amounts of unpaid Class X interest accrue at the Class X Interest Rate or some other rate.

The claimants sought to argue that a failure to pay the correct Class X Interest on an historic payment date would give rise to a “Shortfall” for the purposes of the under Condition 5(i), (a “deferral of interest” provision often seen in structured finance note conditions) and that this would accrue interest at the Class X Interest Rate because this provision specified that the rates of interest applicable to such “Shortfalls” were “the same rate as that payable in respect of the relevant Class of Notes”.

Mr Justice Snowden rejected this argument and agreed with the Issuer that the ‘deferral of interest’ provision did not apply to miscalculations of this nature.  The provision was not designed to deal with miscalculations and no amounts actually become payable unless and until the Cash Manager makes a determination that they are payable.  As a result, no shortfall contemplated by the ‘deferral of interest’ provision would have occurred as a result of a miscalculation.  The reasoning was succinctly put in the following passage of the judgment: The Conditions provide an elaborate mechanism for the determination and publication of the amounts which will become due and payable on the Notes.  Important consequences (such as the occurrence of Events of Default) attach to timely and precise compliance with payment obligations under the Notes, and hence it is consistent with the overall CMBS structure that the payment obligations of the Issuer in respect of the Notes should be defined by those determinations.

Class X Interest on unpaid Class X Interest; a Penalty?

Mr Justice Snowden considered whether the penalty rules would be invoked by Condition 5(i), even if it did apply.  He was not sure that they would be; the question being whether the provision imposed a secondary obligation on the contract-breaker so as to trigger the provisions.  Rather, he questioned whether  the clause was a provision enabling the Issuer to defer its payment obligations until it has sufficient funds to meet them, though did not express a view on whether the clause was a conditional primary obligation (meaning the penalty rules do not apply) or a secondary obligation (meaning they do).

Assuming, however, that the penalty rules did apply to Condition 5(i), the judge considered whether he thought it could amount to a penalty.

His view on this was as follows: “the Class X Interest Amount is not a payment of interest in any conventional sense of that word… it would be understandable for the parties to have intended that the conventional rate of interest applicable to calculate the interest due on the Regular Notes (EURIBOR plus the Relevant Margins) should also be applied to the underpaid amounts of interest, it would be quite another thing – and surprising in the extreme – for the parties to have intended the Class X Interest Rate (which is not a conventional rate of interest) to be used as if it were a conventional rate of interest and applied to any underpayments of the Class X Interest Amount to compensate the Class X Noteholder for loss of use of money… in any conventional terms, the imposition of such interest rates for breach in failing to make payment of a sum due would be regarded as exorbitant (if not extortionate).” (emphasis added).

The argument from the claimants that as the Issuer has the benefit (as in most public securitisations) of obligations that are limited recourse it could not suffer a penalty also did not carry any weight with the judge.  On this, he said: “whether a clause is a penalty cannot therefore depend upon the ability of the particular contract-breaker to pay the specified amount, or the source from which he is to pay… an innocent party cannot save a clause from being a penalty by claiming that even though it provides for payment of a wholly disproportionate amount to the interest which he (the innocent party) has in performance, the contract-breaker is so rich that he will not know the difference.  Nor can he do so by promising to limit his claim to specified funds in the hands of the contract-breaker, if the available amount of those funds would still be capable of paying a wholly disproportionate amount, and payment might deprive the contract-breaker of the ability to pay debts due to other creditors with lower priority”.

Historic Miscalculations are not Events of Default

The judge also considered whether, if he was wrong and there had been a miscalculation and underpayment of amounts historically, this would have amounted to an Event of Default.  He said in his view it would not have constituted an Event of Default on the Notes because the amounts that are due and payable on the notes on any given payment date are only those that are determined by the cash manager to be due and payable.  Elaborating, Mr Justice Snowden wrote: “Standing back, it seems to me that this is an entirely sensible commercial view of the Conditions, and that [the claimant’s] interpretation is without commercial merit.  Given the hugely significant consequences for all parties of the occurrence of a Note Event of Default, I simply cannot see why, at the commencement of the CMBS structure, the parties should be taken to have intended to create what could amount to a concealed “hair trigger”, under which an Event of Default could accidentally occur because of a simple miscalculation of the amount of interest payable, without that fact being appreciated by anyone, and then be incapable of cure at a later date when it was discovered, no matter how solvent the structure might be.”


Once again the English Courts have taken a pragmatic and commercial approach to structured finance transaction documents, in this case, without succumbing to the temptation to re-write the documents.

Mr Justice Snowden gave the Claimants permission to appeal to the Court of Appeal at a hearing on 19 April 2016, and we will report on that in due course.

As matters stand, apart from providing welcome judicial insight into the operation of class X notes, the judgment provides additional clarity on matters applicable to the capital markets in general particularly in relation to events of default and penalties.

Reed Smith LLP advised the successful party, Windermere VII CMBS plc on this dispute.