The recent case of Strategic Value Master Fund Ltd v Ideal Standard International Acquisition S.A.R.L. & others [2011] EWHC 171 (Ch) involved the interpretation of equity cure, acceleration and waiver provisions in an English law facilities agreement.
The case is a first instance decision by Lewison J and the claimant, Strategic Value Master Fund Ltd (the Claimant) was only seeking declarations as to the interpretation of clauses rather than damages or any other substantive remedy. However, it is useful guidance on how quite standard terms in a facilities agreement will be viewed by the courts.
Facts
Bain Capital sponsored the acquisition of the Ideal Standard group (the Target Group) in 2007. The acquisition was funded by credit facilities arranged by two Bank of America entities and a Credit Suisse entity (the Original Majority Lenders), who together formed the Majority Lenders under the credit agreement at all relevant times. The Claimant was a minority lender with a commitment of around 10%. The terms of the facilities were included in a facilities agreement (the Facilities Agreement) dated 3 October 2007 to which Ideal Standard International Acquisition Sarl (the Company), a Luxembourg incorporated entity, was a party. It seems that the Company and the Target Group formed the Group for the purposes of the Facilities Agreement. The Company’s holding company, Ideal Standard International Topco SCA (Topco), fell outside of the Group for the purposes of the Facilities Agreement.
The interest cover covenant in the Facilities Agreement was breached when tested as at 30 September 2009, 31 December 2009 and 30 March 2010. The Facilities Agreement permitted an equity cure of the breach, by allowing the “cash proceeds” received from any “additional Subordinated Debt” to be added to the EBITDA figure for the relevant testing periods. If the interest cover test was then met using the increased EBITDA figure, the breaches of the interest cover covenant and any related Event of Default would be automatically waived. The Company purported to effect an equity cure in accordance with the provisions of the Facilities Agreement on 29 October 2009.
The Agent, acting on the instructions of the Original Majority Lenders, served notice on the Company on 2 February 2010 (the Acceleration Notice) placing the loans under the Facilities Agreement on demand with immediate effect pursuant to the acceleration clause (clause 24.18), on the basis that:
- the interest cover covenant had been breached and the equity cure was not made in accordance with the terms of the Facilities Agreement; and
- the Company was insolvent,
and therefore that the Events of Default associated with those events had occurred.
Companies associated with Bain Capital subsequently purchased the Original Majority Lenders participations and, as Majority Lenders, instructed the Agent to serve a notice on the Company (the Waiver Notice), which was served on 30 June 2010, waiving the breach of the interest cover covenant, waiving any failure to comply with the equity cure provisions, waiving any Event of Default that had occurred as a consequence of the breaches and revoking and withdrawing the Acceleration Notice.
The Claimant disputed whether the Waiver Notice was effective on the basis of the arguments set out below.
The Arguments
Defect in equity cure
The equity cure was effected by Ideal Standard International Holding Sarl (Holding) drawing EUR 75,000,000 from the Group's cash pool on 29 October 2009 and repaying an intra-group loan of EUR 45,000,000 that was owed to the Company. A further EUR 30,000,000 was used by Holding to redeem PPPECs (Luxembourg hybrid debt and equity instruments) issued to the Company by Holding. The Company then used these funds to redeem PPPECs issued to Topco for EUR 30,000,000 and repay an intra-group loan owed to Topco of EUR 45,000,000. On the same day, Topco loaned EUR 75,000,000 back to the Company, which on-loaned those funds to Holding, which in turn returned EUR 75,000,000 to the cash pool. The Topco loan was a "Cure Loan" within the meaning of the equity cure provisions of the Facilities Agreement.
The Claimant's arguments were that:
- the commercial purpose of the equity cure was to improve the financial position of the Group. Simply “round-tripping” cash did not improve the Group's financial position;
- there was no "new money" introduced to the Group;
- the PPPECs included an interest element and any redemption would be a prohibited payment of a dividend under clause 23.13 of the Facilities Agreement; and
- the prohibition on the Company undertaking activities other than those of a “holding company” and “normal treasury and holding company activities” was breached by the mechanism of the equity cure.
The judge rejected all of these arguments.
On the first argument, the judge found that any injection of new debt cannot be said to improve the financial position of a company in financial difficulty. The Claimant modified its argument to claim that the equity cure had to improve the short term liquidity of the Group, but this was undermined by the Claimant's acceptance that the transactions effecting the cure did improve the liquidity position of the Company for a very short period of time (i.e. between the debt repayments and PPPEC redemptions and the monies being reborrowed by the Company and Holding).
On the second argument, the judge found that the equity cure clause did not require "new money", but "additional…Debt". The fact that the funds returned to their source (the cash pool) was irrelevant in assessing whether additional debt had been incurred, and additional debt had been incurred since the Company owed Topco EUR 75,000,000 in debt after the equity cure and EUR 45,000,000 before.
Essentially the judge viewed the equity cure provisions as a mechanical framework that had to be complied with literally rather than imposing a wider commercial requirement for the financial position of the Group to be improved. He pointed out that adding the equity cure amount to EBITDA and excluding it from the calculation of the Group’s Total Debt, as was required by the equity cure provisions, went against the normal accounting treatment of a debt. His view was that the equity cure was “like paying one’s mortgage interest by using a credit card”, and therefore the argument that it had to be interpreted in terms of its improvement of the financial health of the Group was difficult to reconcile with the way the equity cure provisions were drafted. Overall, it was very difficult to interpret the equity cure on the basis of its “commercial purpose” when its permission of the taking on of new debt while the Group was in financial difficulty and the accounting treatment it prescribed for the new debt did not correspond with commercial realities.
The judge rejected the third argument on the basis that, although the PPPECs did have an income element that could be viewed as a dividend, this was capitalised in the consideration paid for the redemption in the same way that a share purchase might be settled after a dividend is announced but before it is paid, and therefore the capital consideration paid will reflect the value of the dividend.
On the fourth argument, the judge found that no evidence as to what constitutes a "holding company" or such a company’s activities had been presented. In addition, the judge found that the Company had to act as a conduit for revolving credit loans, and therefore that receiving and making loans must be within its functions as a holding company.
Insolvency
The insolvency Event of Default in the Facilities Agreement provided that it would be an Event of Default if the Company "is, or is deemed for the purposes of any applicable law to be, unable to pay its debts as they fall due or insolvent". The Claimant argued that the Company was insolvent on the basis of the English law balance sheet test of insolvency, which should have applied because the Facilities Agreement was English law governed. Luxembourg law does not apply a balance sheet test of insolvency, and therefore the Company would only be "insolvent" if an English law balance sheet test of insolvency was applied. The judge rejected this argument and said that the applicable test of insolvency was that of the Company’s jurisdiction of incorporation.
Placing loans on demand
The Claimant argued that placing the loans under the Facilities Agreement on demand in accordance with the Acceleration Notice meant that this substituted the normal repayment provisions of the Facilities Agreement. This would mean that, if the Acceleration Notice were withdrawn, the reversion to the normal repayment schedule would be an "extension of the...maturity... [of] any commitment of any Lender" and would therefore require the consent of all lenders under clause 30.2 of the Facilities Agreement. The judge's view was that, because clause 30.4 of the Facilities Agreement provided that the rights of the Finance Parties were "cumulative", it was not the case that the placing of loans on demand meant that the original repayment right was abandoned.
Waiver of right of acceleration
The Claimant argued that the withdrawal of the Acceleration Notice was an amendment or waiver of the terms of the Finance Documents under clause 30.1(a) of the Facilities Agreement, and therefore clause 30.2, prohibiting any amendment or waiver of the Facilities Agreement’s terms that had the effect of extending the "maturity... [of] any commitment of any Lender" without all Lenders' consent, precluded the withdrawal of the Acceleration Notice unless the Claimant gave its consent.
The judge reviewed various terms of the Facilities Agreement and found that there were four types of waiver provided for under the Facilities Agreement:
- a waiver of a breach;
- a waiver of an Event of Default;
- a waiver of a right or remedy; or
- a waiver of the terms of the Finance Documents.
Counsel for the defendants argued that there was no term of the Finance Documents being waived by the Waiver Notice. The term of the Facilities Agreement permitting acceleration upon an Event of Default subsisted and could be used again. The invocation of the acceleration clause was the exercise of a right. Clause 2.8 of the Facilities Agreement provided that the Finance Parties’ rights were separate, and Clause 30.4 of the Facilities Agreement provided that "the rights of each Finance Party...may be waived only in writing and specifically". Given that the Majority Lenders had a separate right of acceleration, it followed that only the Majority Lenders could waive that right under clause 30.4 of the Facilities Agreement.
Relying on the House of Lords decision in Banning v Wright [1972] 1 WLR 972, the Claimant argued that there was no distinction between the waiver of a term and the waiver of a right. Banning v Wright concerned the interpretation of section 22(4) of Finance Act 1963 and whether the words "for the variation or waiver of the terms of a lease" captured a payment made by a tenant to a landlord to allow unauthorised sub-tenancies to continue and allow an option to renew to continue despite the resulting breach of the lease. The House of Lords decision found that a waiver was essentially a waiver of a right to invoke a term. By analogy, the Claimant argued that the waiver of the right of acceleration was a waiver of a term within the meaning of clauses 30.1 and 30.2 of the Facilities Agreement and therefore required all lenders’ consent.
The judge distinguished Banning v Wright on the basis that it concerned the interpretation of a statutory provision, whereas he was obliged to interpret the terms of the Facilities Agreement. The judge's interpretation of the judgment in Banning v Wright was that it did not preclude differentiating the waiver of a right from the waiver of a term, and that in any event the drafters of the Facilities Agreement had drawn clear distinctions between the four categories of waiver set out above. The judge found that the defendants’ counsel's interpretation was the correct one, and therefore that the provisions of the Facilities Agreement relating to waivers of terms (clauses 30.1 and 30.2) were not relevant to the withdrawal of the Acceleration Notice.
Agreement not to make demand following acceleration
While this argument was irrelevant given the judge’s findings on the other arguments, the judge considered it for the sake of completeness. The defendants argued that the Waiver Notice constituted an agreement by the Majority Lenders not to make a demand for repayment of the accelerated loans to the extent that the waivers in the Waiver Notice were not effective. The Claimant argued that the Waiver Notice was predicated on the waiving of the breaches and Events of Default set out in the Waiver Notice. If the waivers were not effective then there could be no agreement since the agreement was based on an incorrect assumption.
The judge referred to the judgment of Arden LJ in Anglo Continental Education Group (GB) Ltd v Capital Homes (Southern) Ltd [2009] CP Rep 30 in determining that, where the drafting is problematic and neither party's argument on interpretation is convincing, the court will tend to prefer an interpretation that renders the agreement effective rather than void and will prefer an interpretation that produces a result that the parties are likely to have agreed rather than an improbable result. Therefore, irrespective of any issue with the underlying basis for the agreement, the withdrawal notice did constitute a binding agreement not to make a demand for the accelerated loans since this is likely to be what the Majority Lenders and the Company intended.
Conclusion
The facts of the case and the date of the Facilities Agreement suggest that the undertakings and covenants imposed on the Group were far weaker than would be tolerated in the present market. For example, the freedom to use the monies in the cash pool and the ability to make distributions or equity redemptions or repay debt owed to companies outside the Group would be far more restricted than appeared to be the case under the Facilities Agreement. However, the decision shows that consideration must be given to the precise wording of the facilities agreement rather than relying on whatever “commercial purpose” is in the parties’ minds in order to prevent borrowers exploiting weaknesses in the covenants.
To the extent that lenders want an equity cure to have a “commercial purpose” or involve “new” money, this will need to be detailed in the equity cure provisions of the facilities agreement. Prohibitions on payments, disposals and distributions in both the facilities agreement and the intercreditor agreement will also need to be robust enough to prevent the “round-tripping” seen in this case.
The decisions regarding the withdrawal and waiver of the Events of Default show that the courts should adopt a pragmatic approach in interpreting the rights of the finance parties under facilities agreements, but it may be that facilities agreements should be clearer by specifically providing that those finance parties that are entitled to exercise a right are the only finance parties entitled to waive the underlying breach or discontinue the exercise of that right.
The case also shows the importance of considering the practical consequences of what might seem like “standard” wording, rather than relying on what might seem the obvious method of interpretation when viewed from a client’s perspective. The judge was at pains to point out that a court will interpret ambiguous clauses by having regard to the commercial intent of all parties, not just the interpretation of a party relying on the clauses to support its arguments.
