“Are you anticipating a debt rescheduling?”

Two recent cases (Torre Asset Funding Limited & anr v The Royal Bank of Scotland plc [2013] EWHC 2670 (Ch) and Grupo Hotelero Urvasco S.A. v Carey Value Added S.L. [2013] EWHC 1039 (Comm)) have considered the oft forgotten event of default buried deep in a loan agreement which arises when a borrower seeks to reschedule its indebtedness where financial difficulties lie behind the request. The cases provide a warning to borrowers about how easily such events of default can be triggered.
The relevant clauses (the drafting of which was very similar) provided that a default would arise if, due to actual or anticipated financial difficulties, the borrower began negotiations with any of its creditors for the rescheduling of any of its indebtedness.

In Grupo Hotelero the borrower was in discussions with a number of its lenders about facilities that were due to mature shortly. Blair J. held that the concept of rescheduling of indebtedness required the formal variation of financing arrangements, and that discussions that occurred in the ordinary course of a borrower’s business would not trigger the clause. The wording of the default clause required that the negotiations needed to be in the context of the borrower’s actual or anticipated financial difficulties. However Blair J. held that borrowers could not disguise a rescheduling of debt as the maturing of one facility and the entry into of a new facility “if the agreement of new terms was linked to non-payment of the existing facility, and the consequent threat of legal action”.

In the Torre Asset Funding case, in October 2006 the claimant had provided mezzanine debt facilities to the Dunedin property group alongside other various layers of debt. The defendant acted as agent for those mezzanine lenders. In July 2007 the borrower and the Agent exchanged emails in which the borrower made clear that the group’s performance was significantly below the financial projections and it was therefore proposing for certain interest payments to be rolled up and paid at the final maturity date for the loans in 2011. In September 2008, as a result of the downturn in the property market, Dunedin entered administrative receivership and the claimant, a subordinated creditor, did not recover any of its loans. One of the issues in the case was whether the discussions between the borrower and the Agent in July 2007 had triggered the ‘negotiations with creditors’ default.

Part of the issue for consideration by the court was whether the rescheduling of indebtedness was caused by financial difficulties (actual or anticipated) of the borrower. The borrower (the Dunedin group) was highly leveraged and it was clear from the outset that it would have to perform to its business plan in order to generate sufficient income to service the interest payments due to the various tiers of lender. It was apparent that the requested deferral was required to allow the Dunedin group to avoid defaulting on its other payment obligations. Sales J found the group to be in financial difficulty because “this anticipated inability to service the debt … could not be regarded as an ordinary or expected incident…”. The High Court concluded that a default had been triggered by the email discussions between Dunedin and the defendant in July 2007, despite the fact that the relevant lenders’ consents were not forthcoming to allow the proposed interest deferral to be effected.

Both cases remind borrowers to be cautious about approaching their lenders on the subject of amending payment terms, even where it is encouraged or requested by the debt providers. Due to the drafting of the clause, it was not necessary that negotiations be held with all of a borrower’s creditors for the default to be triggered. However, the judges in both cases made it clear that the context of the event of default meant that any such actual or anticipated financial difficulties had to be substantial in nature.

It is worth noting that the LMA recommended forms of facility agreement differ in their formulation of the ‘negotiations with creditors’ default. While the LMA investment grade facility agreement provide that any negotiation with creditors with a view to rescheduling indebtedness in the context of financial difficulties will trigger the Event of Default, the LMA leveraged and real estate finance facility agreements specifically carve out negotiations with a "Finance Party in its capacity as such". Borrowers should check their loan documentation to establish which formulation of this default has been used.

Where the form of provision used in the above cases could apply, borrowers should ensure that discussions only take place following a confirmation from the lenders that a default won’t arise. Or perhaps more importantly, borrowers should, when negotiating their loan agreements, limit the operation of the clause to negotiations with creditors generally rather than individually, or at least ensure that the carve out contained in the LMA leveraged and real estate finance facility agreements is included.