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Industry Updates

Using Regulatory Background to Interpret Note Issuance Documents

29 Jun 2016

The interpretation of a contract depends on the objective meaning of the words used in their commercial context. However, courts exercise considerable caution before permitting parties to use "context" to incorporate extraneous material which is really designed to shore up one party's subjective preferred meaning. This is not allowed (save where the party contends that the contract should be rectified because it did not reflect the mutual intention of the parties – a difficult remedy to obtain).  The UK Supreme Court decision in the BNY Mellon case 1 is a good example of how regulatory context can play a vital role in interpreting contractual terms, where the contract is driven by regulatory considerations.  This decision will be of persuasive authority in Ireland. The same general rules for the interpretation of contracts apply in Ireland.


LBG Capital No 1 Plc was a special purpose vehicle set up by Lloyds Banking Group (the "Bank") in order to raise £8.3 billion worth of capital to meet then applicable regulatory capital requirements in 2009.  These were long-dated contingent convertible (or "coco") notes and carried a high rate of interest (over 10% per annum).  At the time of the litigation some £3.3 billion of the notes were still in issue, £5 billion having been exchanged for other notes.  They were designed to convert into shares if the Bank's capital position deteriorated such that it did not have enough Tier 1 capital.  The regulatory provisions were complex, but in summary the conversion "trigger" was set at 4% - the then applicable minimum capital ratio after regulatory "stress-testing".  However, due to regulatory changes after 2009 the applicable minimum was raised to 7%.  This meant that the notes failed to perform the function for which they were originally designed. In light of the regulatory change after the notes were issued, the trigger had been set too low.

The trust deed for the notes allowed the Bank to redeem the notes if they would no longer be "taken into account" in regulatory stress-testing.  The Bank wanted to redeem the notes given the very high coupon, and because they no longer performed their intended function.  The trustee of the notes (BNY Mellon) contended that the Bank was not entitled to redeem the notes – its principal argument being that if the notes somehow converted into shares then they would then be "taken into account".  The Bank's position was that this was never going to happen due to the low level of the conversion trigger.

Outcome and Rationale

The Supreme Court rejected the trustee's argument.  It held that redemption provisions should be interpreted in the context of the regulator's statements at the time setting out the parameters for capital adequacy.  The purpose of the notes was to enable the Bank to meet then applicable regulatory requirements – the 4% test.  In that context the notes would be "taken into account".  However, they would never in fact be "taken into account" if the test was 7% - because the Bank would then have breached its capital requirements long before the conversion trigger was reached.

The Supreme Court also rejected an argument by the trustee that the redemption clause did not apply at all because of a change in the description of the relevant classes of regulatory capital.  The court described this argument as "pedantic" and "arid".


There are two lessons to be learned from this decision.

First, great care needs to be taken in defining contractual preconditions by reference to regulatory events.  In this case the regulatory landscape changed radically.  The case shows that regulatory-critical provisions need special attention so that they adapt to the ever-changing regulatory environment.

Secondly, in cases of ambiguity a court can legitimately consult relevant regulatory background to find out what the contract means, on an objective basis and in context.  What is unclear, at least in an Irish context, is whether such readiness would apply where the contract is between a regulated financial institution and a customer – especially a consumer.  In the BNY Mellon case the parties were sophisticated and well-resourced market participants.  It remains to be seen whether this readiness will be apparent in bank-customer disputes.  However, it seems likely that where the customer uses the right of action under section 44 of the Central Bank (Supervision and Enforcement) Act 2013 to sue for damages caused by regulatory breaches, regulatory context is likely to be all-important.

For further information on any of the above matters, please liaise with your usual Maples and Calder contact.

1 BNY Mellon Corporate Trustee Services Limited v LBG Capital No. 1 Plc [2016] UKSC 29

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