The appellant junior noteholder (N) appealed against a decision (2014 EWHC 1083 (Ch)) that a substantial sum of money representing unscheduled principal proceeds (UPP) was not available for reinvestment as it did not meet the reinvestment criteria specified in a collateral management agreement (CMA).
The first respondent issuer (H) issued 14 classes of notes which were secured on the proceeds of an underlying portfolio of loans originally owned by H under a collateralised loan obligation (CLO) structure. The different classes of notes had different priorities for redemption and each note carried a different rate of interest. A dispute arose between the senior noteholders and the junior noteholders over whether the UPP was available to be reinvested or should be paid out to noteholders. Under the reinvestment criterion 4(i) in the CMA, the UPP could only be reinvested if the ratings of the senior notes "have not been downgraded below their initial ratings". The senior notes were downgraded in 2010 from their initial rating of AAA to AA and were then upgraded in 2012 back to AAA. The UPP were not reinvested in 2014 on the basis that the reinvestment criteria had not been met. The judge held that the language of criterion 4(i) was clear and unambiguous and, applying its ordinary meaning, the UPP were not available for reinvestment due to the previous downgrade and were incapable of being satisfied.
N submitted that the judge had adopted an unduly narrow grammatical reading of the criterion which failed to take account of its obvious purpose and context, and that an iterative approach was required. The fourth respondent trustee (D) contended that the judge, having decided that the meaning of the phrase was clear and unambiguous, had no need to consider the rival commercial considerations of the competing interpretations and, in any event, his decision made commercial sense due to the significance of the downgrade of the notes' ratings.
An iterative process was not confined to textual analysis and comparison. It extended to placing the rival interpretations of a phrase within their commercial setting and investigating their commercial consequences, Sigma Finance Corp (In Administration), Re  UKSC 2,  1 All E.R. 571 followed. The court should seek to discern the commercial intention and the commercial consequences from the terms of the contract itself, and that fed in to the process of deciding whether a particular word or phrase was in reality clear and unambiguous. Where possible, the court should test any interpretation against the commercial consequences. That was part of the iterative exercise of interpretation. It was not merely a safety valve in cases of absurdity, Rainy Sky SA v Kookmin Bank  UKSC 50,  1 W.L.R. 2900 followed. The language of criterion 4(i) was open to question. The disputed phrase was capable of referring to something which was continuing. The judge correctly said that the tense was present perfect but he took too narrow a view of the possible usages of that construction. The instant court disagreed with the judge that, in ordinary usage, the phrase could only refer to a past historic event at some indefinite point. It was important to consider the overall structure of the transaction. The parties agreed that a downgrade followed by an upgrade did not have continuing consequences. During the reinvestment period a downgrade of the notes had no contractual effect. Reinvestment of all principal proceeds including UPP proceeded as though the downgrade had never happened. D's interpretation raised the effect of a historic downgrade of the senior notes to a level of pre-dominance which it was not designed to have in a context where, if given that level of pre-dominance, it conflicted with the basic scheme of the CLO (see paras 31-33, 39, 43-44, 48-49 of judgment).
For the appellant: Robert Miles QC, Gregory Denton-Cox
For the fourth respondent: Richard Snowden QC, David Allison QC
For the appellant: Bingham McCutchen LLP
For the fourth respondent: Allen & Overy LLP
Full judgment – http://www.bailii.org/ew/cases/EWCA/Civ/2014/984.html