LEGAL CHANGE

Case law and trending topics

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About the author

Stephan Smoktunowicz is a banking & finance partner at the London office of the international law firm, gunnercooke. He helps businesses & people in the UK and across the world to achieve their commercial objectives and safely navigate issues that arise throughout any transaction lifecycle. He also provides training and mentoring to businesses, professionals and students on related topics.

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In this issue

I look at recent topics considered by the English courts and other recent banking and finance related news. 

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Intercreditor and priority arrangements

Intercreditor and priority agreements play a key role in marshalling the payment and receipt of monies owed by a common debtor to multiple creditors, both in non-distressed and distressed scenarios.

Before entering into these types of agreements, creditors need to ensure that they understand the commercial effect of the drafting. Otherwise, there could be potential for unexpected losses or a dispute down the line.

What have recent cases on intercreditor and priority arrangements highlighted?

There have been several cases in the English courts on this topic over recent months which have highlighted that:

• if after a specific trigger date and until its debt is fully repaid, a creditor wants to prevent a debtor from making payments to competing creditors or those creditors from making recoveries from any enforcement action, the intercreditor drafting must be unambiguously clear on that;
• junior creditors need to be aware of how the drafting of intercreditor/priority agreements can dilute or extinguish their ability to be paid out of security enforcement proceeds (for example, via widely drafted definitions of what the senior debt is or the absence of controls around the ability to increase senior debt or amend or replace senior facility documents).

Comment

Whist it is usual to see term sheets for loan agreements (which can then be translated into the underlying agreement itself), term sheets governing priority or intercreditor agreements are not always used.

Furthermore, where intercreditor agreements are based on standard form documents or drafted using in-house automation processes, careful adaptation and review by a sufficiently experienced lawyer remains key to ensuring that signed documents reflect the commercial intention.

Ultimately if you want to minimise the risk of losses or court scrutiny, then given their complexity, the care and attention given to the planning and drafting of intercreditor agreements should be equal to if not greater than that given to the underlying loan, credit or other commercial agreement.

Whilst another creditor may not always be prepared to concede ground in intercreditor negotiations (for example, where they hold the vast majority of the debt), by focusing on what is commercially acceptable to you, boundaries and parameters can be created which can be translated into appropriately drafted protections or risk assessed if they are crossed during negotiation.

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The risks of using email correspondence

Well drafted agreements will typically include a clause which only allows amendments and waivers to be made in writing.

However, the English courts have recently had to consider the impact of email communications and whether they amounted to a waiver of rights under a loan agreement (this is not the first time that the legal effect of an email has come before the courts!).

Whether or not an e-mail amounts to a waiver will usually turn on the facts and the content of the email and underlying agreement. However, as business processes become more and more electronic/automated, there is always the risk that an email or written content within a platform could have unintended consequences, particularly if another party places reliance on it.

Operational considerations

Monitoring or checking every single email that is sent within a business before it is sent by anyone other than the sender is unlikely to be operationally feasible.

However, if a contract is of high value or business importance, having internal checks and balances in place around customer communications will add some protection against the risks of an email or other electronic communication inadvertently waiving important contract rights.

Alternatively, saying in the underlying agreement that (i) email waivers can only be provided by key employees/directors, or (ii) email cannot be used for waivers (or for waivers of specified key rights) and that they need to be in writing and signed on behalf of the waiving party by a named person(s) could also reduce the risk of emails accidentally waiving important rights.

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Interest rate mechanics

With LIBOR now being consigned to the history books, loan agreements containing historic LIBOR interest pricing mechanics should now have transitioned to SONIA/SOFR rates.

However, outside of the main loan market where there has been a huge focus on successful rate transition, other legacy agreements and commercial contracts could still exist that contain reference to pricing in LIBOR for future payments, but which do not contain workable fallback rates.

The English courts have recently looked at an example of this, where dividend payment pricing mechanics relating to preference shares were calculated by reference to the 3 month US Dollar LIBOR rate. However, the fallback mechanics did not provide a mechanism to be able to make the necessary calculations.

Options

A court will typically consider two options in a situation like this. Either to say the contract no longer works (which may not be beneficial to either party) or to try and keep it alive by implying a term if appropriate.

In the case in question, the court found that it was an implied term that if the US Dollar LIBOR definition had ceased to be workable, dividends were instead to be calculated by reference to a reasonable alternative rate.

The ‘reasonable alternative rate’ was held to be that produced by taking the CME Term SOFR rate and adding the corresponding ISDA Spread Adjustment – i.e. one that reflected common market practice based on findings of the court.

Whether or not the rate the court implied would be the closest rate to the previous LIBOR rate in all economic conditions was, however, the subject of some debate. But with LIBOR no longer in operation, ultimately there will be no exact comparison to compare the new implied rate against going forwards in any event.

Key takeaway

Parties to agreements which still refer to LIBOR for the calculation of future payments and do not have adequate fallbacks may be able to take some comfort from this case that a court may if necessary, imply a term that pricing is to be calculated by reference to LIBOR replacement market norms. However, getting a court’s view is not without cost and mutual agreement to amend existing provisions may provide a more cost effective option, assuming that all parties are on the same page.

However, the safest route for any contractual pricing mechanism to work consistently according to the parties’ original wishes, is to have agreed, workable fallbacks should one rate for any reason be unavailable or no longer published. This is particularly important when using non-industry standard worded templates.

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DIGEST – COMMENT ON OTHER NEWS

The UK October Budget

The new Chancellor of the Exchequer, Rachel Reeves, delivered her first budget on 30 October 2024. Whilst the speech to the House of Commons was a fairly lengthy 77 minutes, a lot of the fine detail remains to be seen and discussed. For those of a curious nature (or alternatively for those suffering from insomnia) the budget report contains more lengthy detail.

On the face of it, despite the rise in employers’ national insurance contributions, there are some measures aimed at helping businesses. For example, £250 million in funding in the next tax year for the British Business Bank’s small business loans schemes and facilitating greater access to support for businesses from UK Export Finance.

The budget report also reiterates the launch of the National Wealth Fund which is intended to mobilise billions of pounds of investment into clean energy and growth industries and support the delivery of the government’s industrial strategy.

And those on either side of financial covenant setting, testing and calculations may wish to pause for thought and consider what if any impact the budget measures may have….

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Director duties

The Company Directors (Duties) Bill, a private members’ bill sponsored by Liberal Democrat MP, Martin Wrigley has had its first reading in the House of Commons.

The Bill is proposed to make changes to section 172 of the Companies Act 2006 (Duty to promote the success of the company) and if implemented, it is expected to require company directors to balance their duty to promote the success of the company with duties in respect of the environment and the company’s employees.

Whilst a draft of the proposed Bill is not yet available, this will be one to watch for directors. With the focus on clean energy and environmental related matters continuing to make regular headline news, it would not be surprising if this legislation was used as a way of getting all companies and their directors to maintain focus on how their day to day decisions are impacting the wider world in which we live.