Distribution - First defendant issuing mortgage backed securities (notes)

Deutsche Trustee Company Ltd v Fleet Street Finance Three plc and another: Chancery Division (Mr Justice Vos): 9 September 2011

The claimant trustee company (the trustee) was the trustee under a trust deed dated 19 June 2007 (the trust deed). The first defendant company (the issuer) was the issuer of notes (the notes) divided into various classes constituted by the trust deed. The second defendant was the holder of €60m of the Class A1 notes. The notes were a species of commercial mortgage-backed securities and were subject to various terms and conditions contained in schedule 2 to the trust deed (the conditions).

The issuer applied the net proceeds of the issue to purchase interests (the senior loans) in five term loans (the whole loans) secured by portfolios of properties situated in Germany and the Netherlands. The repayment of principal and interest by the borrowers under the senior loans provided the issuer with its principal source of funds to make payments under the notes, and the notes were subject to mandatory early redemption in the event that the senior loans were repaid.

The issuer acquired the senior loans only in relation to the C, BS, O and the Saxony whole loans. In each case there were also junior lenders whose rights were subordinated to those of the senior lenders pursuant to individual intercreditor agreements (the Intercreditor Agreements) and there was also a facility agreement governing the terms of the senior lenders' arrangements. In the case of the GSW senior loan there were no junior lenders, and therefore no intercreditor agreement, but the issuer acquired a 25% share in the GSW senior loan.

Condition 6.2 of the conditions provided that if there was a 'material senior default' on one of the C, BS, O or the Saxony senior loans (a sequential payment trigger), the amounts received in respect of that particular senior loan were to be applied sequentially (trigger (ii)). A 'material senior default' was defined in that paragraph by reference to the relevant intercreditor agreements. Condition 6.2 also identified three further sequential payment triggers, triggers (i), (iii) and (iv) (see [33] of the judgment).

Conditions 6.2(a) and 6.2(b) explained how the issuer would distribute the pro rata redemption amount and the sequential redemption amount respectively (see [30]-[32] of the judgment), before the happening of a sequential payment trigger. On 15 April 2010, the Saxony facility agreement was amended to extend the final maturity date of the S senior loan from 20 January 2011 to 13 July 2013. On 20 January, the Saxony whole loan was originally due to mature, but was not repaid due to the amendment to the Saxony facility agreement.

On 15 February, the outstanding principal amount of the GSW senior loan in the sum of about €220m was prepaid in full (the prepayment). On 15 June 2011, the trustee issued proceedings, the immediate effect of which was to determine the proper recipients of the prepayment, of which some €24.47m remained to be distributed.

The principal issue that fell to be determined was whether there had been a material senior default in respect of the Saxony senior loan under paragraph (ii) of the definition of sequential payment trigger in condition 6.2. The question turned on whether the amendment made to the Saxony facility agreement so as to postpone its final maturity date was to be taken into account or disregarded when construing paragraph (ii).

The second defendant submitted that: there had been a material senior default of the Saxony senior loan under trigger (ii) because, even though the words in brackets in trigger (ii) did not refer expressly to the Saxony facility agreement, but only to the Saxony intercreditor agreement, they had to be taken as meaning that the question of whether there had been a material senior default had to be judged under trigger (ii) by reference to the state of affairs at the date of the issue; trigger (i) would still be activated if payment were not made by the original unamended final maturity date and, in the circumstances, it was obvious that the same fixed trigger had been intended for trigger (ii) as for trigger (i).

He further submitted that, the words 'based on' were important in the bracketed words in trigger (ii) as they gave the whole parenthesis a broader meaning than simply referring to the intercreditor agreement, and required reference to the 'terms' of such intercreditor agreements as at the issue date, including the underlying facility agreement as they stood at that time, accordingly, references to the Saxony intercreditor agreement had to be taken as including a reference to the Saxony facility agreement, which had extended the final maturity date of the loan.

The court held: It was established law that in order to correct a mistake by construction, two conditions had to be satisfied. First, there had to be a clear mistake on the face of the instrument. Secondly, it had to be clear what correction ought to be made in order to cure the mistake. In deciding whether there was a clear mistake the court was not confined to reading the document without regard to its background or context.

Where a security document secured a number of creditors who had advanced funds over a long period, the instrument had to be interpreted as a whole in the light of the commercial intention which might be inferred from the face of the instrument and from the nature of the debtors business (see [45]-[46] of the judgment).

On the evidence, there had not been a material senior default in respect of the Saxony senior loan under para (ii) of the definition of sequential payment trigger in condition 62. The second defendant's argument was based upon the suggestion that the draftsman of the definition of sequential payment trigger had, in effect, made an obvious mistake.

However, the wording of the brackets in trigger (ii) was quite clear. Looking at the contractual documentation in the round, against the relevant factual matrix, it did not seem that there had been a clear mistake on the face of the instrument; the definition might have intended a partially fixed approach in trigger (i) and a more flexible one in trigger (ii).

Further, the words 'based on' could not expand the reference to the Intercreditor Agreements to a reference to the facility agreements as well. A material senior default had not occurred in relation to the Saxony senior loan by virtue of non payment on the original maturity date of 20 January 2011.

Trigger (ii) required only amendments to the intercreditor agreements and the Saxony intercreditor agreement in particular, to be disregarded. Accordingly, trigger (ii) had not been activated in respect of the Saxony senior loan since the amended final maturity date had not been reached (see [63], [67], [71], [77] of the judgment). On the proper application and true construction of condition 6.2, the GSW funds were to be applied partly by pro rata and partly by sequential payments in accordance with conditions 6.2(a) and (b) (see [77] of the judgment).

Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] 3 All ER 352 applied; Investors' Compensation Scheme Ltd v West Bromwich Building Society, Investors' Compensation Scheme Ltd v Hopkin & Sons (a firm), Alford v West Bromwich Building Society, Armitage v West Bromwich Building Society [1998] 1 All ER 98 applied; Chartbrook Ltd v Persimmon Homes Ltd [2010] 1 All ER (Comm) 365 applied; ING Bank NV v Ros Roca SA [2011] All ER (D) 39 (Apr) applied; Rainy Sky SA v Kookmin Bank [2011] 1 All ER (Comm) 18 applied.

Robert Miles QC and Richard Hill (instructed by Allen & Overy LLP) for the trustee. Simon Mortimore QC and Marcus Mander (instructed by Jones Day LLP) for the second defendant.