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When is an SPV a “financial institution”?

In a judgment that will be welcomed by lenders and holds a cautionary lesson for borrowers on the importance of precise contract drafting the High Court in Re Olympia Securities Commercial plc (in administration) and ors v WDW 3 Investments Ltd and anor has ruled on what a “financial institution” is in the context of the assignment and transfer provisions in a commercial term loan facility agreement.

Background to the dispute

Following the collapse of Anglo Irish Bank Corporation Limited (the “Lender”) in 2013 the liquidators sold a portfolio of the Lender’s loan receivables to LSREF III Wight Limited (“LSREF”). Part of that portfolio were loan receivables payable from Olympia Securities Commercial Plc (the “Borrower”) under a term loan facility agreement entered into with the Lender in 2005 and a related interest rate swap secured by a debenture over the assets of the Borrower. As part of the agreed sale to LSREF the liquidators assigned the Lender’s rights under the facility agreement to LSREF’s appointed nominee WDW 3 Investments Limited (“WDW”). WDW itself was a company with no trading history, having been incorporated for the sole purpose of the transaction two weeks before the assignment took place, and a share capital of just £1.

When the Borrower subsequently defaulted under the facility agreement and went into administration a dispute arose between WDW and an unsecured creditor (“Arazim”) of the Borrower as to which of them had a valid claim to £6 million held by administrators.

Arazim argued that the assignment of the Lender’s rights under the facility agreement to WDW was invalid (and that therefore WDW had no claim to the £6 million) because the assignment did not comply with the relevant assignment and transfer provisions of the facility agreement. Clause 23 of facility agreement stated as follows (with emphasis added):

23.2 The Lender may (and the Borrower shall assist as required and irrevocably appoints the Lender to execute any requisite document on its behalf) at any time transfer, assign or novate all or any part of the Lender’s rights, benefits or obligations under this agreement to any one or more banks or other financial institutions. All agreements, representations and warranties made in this agreement shall survive any transfers made pursuant to this clause. The Lender may sell down its participation in respect of the Finance Documents without the consent of the Borrower”.

The dispute was referred to the Court by the administrators who sought directions as to which creditor should receive the payment.  The question before the Court was therefore whether WDW was a “financial institution” within the meaning of clause 23.2 of the facility agreement.

High Court Judgment

Pelling J, following the meaning given to the phrase by of the Court of Appeal in Argo Fund Limited v Essar Steel Limited [2006] 1 CLC 546 (“Argo”), held that WDW did fall within the meaning of a “financial institution” and that, in the context of assignment of a commercial loan agreement with a commercial borrower, a “financial institution” was:

a legally recognised form or being, which carries on its business in accordance with the laws of its place of creation and whose business concerns commercial finance” (para. 21).

Pelling J noted that the phrase “financial institution” was not defined in the facility agreement and as an expression was “ambiguous”. Furthermore, Pelling J found that, applying the usual English law principles of contractual interpretation was of limited assistance as “it was difficult to discern any relevant commercial context that could be said to illuminate how the concept of a financial institution would have been perceived by reasonable people in the position of the parties”. In fact Pelling J found that the best that could be said of the expression was that it: “indicates that the parties intended to limit the class of potential assignees”. (Para. 18)

Pelling J endorsed the analysis of Auld LJ in Argo that, in deciding on such a wide definition of “financial institutions” the following points were particularly relevant:

  1. The reference to “bank” preceding the phrase “financial institutions” did not require the “financial institution” to exhibit any particular standard of suitability or probity as a financial institution and that the few residual obligations of lenders after draw-down are insufficient to restrict the range of entities to which debt may be passed in the secondary debt market (Para. 49 of Argo);
  2. In light of the “spare” nature of the expression it was not open to borrowers to argue that it the expression was intended to only refer to “a sound and respectable lender”. If the parties had intended transfer provisions to be restricted in this way “they could and would have done so in clear terms”. (Para. 50 of Argo); and
  3. The commercial reality was that any lender, whether original or as transferee, should be entitled to recover the borrowed monies when due under the facility and that the borrower “whether distressed or otherwise, has and need have little interest as to the commercial or financial status of the body to which the role of lender has passed”. (Para. 52 of Argo)

Pelling J dismissed Arazim’s arguments that having a share capital of just £1 and being a special purpose vehicle with no trading history precluded WDW from being a “financial institution”. He noted that any legal test relating to either share capital or trading history would be entirely arbitrary, lacking in reality and that, while such arbitrary definitions could be used in the contract itself, that a court could not adopt the same approach.

Analysis

The use of the expression “banks or other financial institutions” or similar variations are very common in the transfer provisions of facility agreements so it will be welcome news to lenders that, on its own, this language has such a limited effect in terms of restricting the pool of potential buyers on the secondary market.

While it may seem odd to think that the expression “financial institution”, on a common-sense reading could really include a non-trading company with £1 share capital the key point stressed in both Argo and this decision is that it is always open to the parties to expressly agree a narrower definition. As a result, borrowers should pay careful attention to the drafting of the transfer provisions in a facility agreement if they wish to limit the classes of entities to whom the loan can be transferred. Lenders should also take great care regarding the drafting of transfer provisions as in a difference case, on different wording and / or different facts, the court might come to a different conclusion.

Druces LLP’s commercial litigation and banking teams act on, and advise clients in relation to, all aspects of debt financing transactions. If you would like to discuss any of the issues raised in this briefing please speak to either Charles Spragge, Simon Pullen or Max Palmer.

This briefing was posted on 24 January 2018