{{ languageVal }}
  • English
 

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.

Facts

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".

Implications


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

Related Services

Legal Services

Access to market leading legal advice across a wide range of industries and sectors is paramount to the success of businesses seeking international expertise with local support. The Maples Group's legal services teams are globally coordinated, with consistent systems, policies and procedures across all offices, and connected by a common goal: to deliver the highest quality advice and solutions to our clients. Offering an extensive range of legal services, we advise financial, institutional, business and private clients on the laws of the British Virgin Islands, the Cayman Islands, Ireland, Jersey and Luxembourg, delivering time zone convenience and accessibility from these and other leading key international financial centres. Through constructive dialogue and engagement with governments, regulators and industry associations, we have helped shape financial industry innovation and regulation in many of the jurisdictions in which we operate.

Finance

Advising on the laws of the BVI, the Cayman Islands, Ireland, Jersey and Luxembourg, our global Finance team provides expert legal advice on even the most complex financial transactions under intense time pressure. Clients repeatedly return to our qualified finance lawyers to handle a variety of complex matters relating to acquisition and leveraged financing, asset finance, banking, debt capital markets, derivatives, fund finance, insurance linked products, Islamic finance, repackaging and structured finance. 

Dispute Resolution & Insolvency

Advising on the laws of the BVI, the Cayman Islands and Ireland, our global Dispute Resolution & Insolvency team provides expert legal advice on cross-border litigation and contentious and non-contentious restructuring.  We offer a broad range of dispute resolution and insolvency services, bringing an unrivalled depth of experience to each dispute and ensuring that you receive fast, accurate and pragmatic advice.