Loan investors and traders take note of the Judgment of the UK Supreme Court on 11 March 2015 in Tael One Partners v Morgan Stanley & Co International PLC [2015] UKSC 12.  The Court addressed the treatment of loan “premium” under the LMA Standard Terms and Conditions and whether it is for the account of the Seller or the Buyer.

The Loan Market Association (“LMA”) Standard Terms & Conditions for Par & Distressed Trade Transactions (Bank Debt/Claims) (the “Terms and Conditions”) are the recommended set of terms published by the LMA and commonly used for the trading of loans and claims in the secondary market outside of the United States.  It is important to remember however, that the LMA Terms and Conditions may not expressly address all the underlying loan economics or reflect the status of the borrower’s restructuring, and traders are free to negotiate specific terms at the time of trade where there may be any ambiguity as to who receives the benefit of certain fees, interest or premium.

Tael One Partners Limited v Morgan Stanley & Co International PLC [2015] UKSC – The Facts: 

The appellant, Tael One Partners Limited (“Tael”) was one of a number of lenders under a US$100 million syndicated facility agreement (“the “Credit Agreement”) to Finspace SA (the “Borrower”).  It sold and transferred $11m of its total $32m participation in the loan to Morgan Stanley & Co International PLC (“Morgan Stanley”) on 14 January 2010 which was documented by a LMA trade confirmation (incorporating the LMA par terms), transfer certificate and pricing letter.

The Credit Agreement provided for a payment premium to be paid by the Borrower to the lenders at the same time as prepayment or repayment of the principal of the loan, which enhanced the rate of return to the lenders to a total of either 17% or 20% per annum, depending on the circumstances in which the loan was prepaid or repaid.

The trade transaction settled and the pricing letter executed by the parties made no reference to premium, nor did it provide for any further payment by Morgan Stanley to Tael in respect of premium.

In March 2010, Morgan Stanley sold its position under the Credit Agreement to Spinnaker Global Strategic Fund Limited.  The Borrower refinanced the loan and prepaid it in full on 16 December 2010.  In accordance with the premium provisions, the Borrower paid an amount in respect of premium to all the lenders who held a position in the Credit Agreement on the prepayment date.  Those lenders included Tael and Spinnaker, but not Morgan Stanley.  Tael then claimed under the LMA Standard Terms and Conditions that Morgan Stanley was required to pay the premium to Tael in respect of the US$11m participation, so far as it had accrued as at the date of transfer (14 January 2010).

What is “premium” and how do the LMA Terms and Conditions apply?  

The LMA Terms and Conditions do not define the concept of “premium”. There was some debate by each court as to whether premium constitutes interest or a fee, and if a fee, whether it is to be considered a “Recurring Fee” (which is defined as a fee expressed to accrue by reference to time elapsed) or a “Non-Recurring Fee” (being any fees that are to be paid to a Lender that are not Recurring Fees).

On reflection of the arguments, premium was not considered to be “Interest” as defined under the LMA Terms and Conditions; however, it was capable of being a “Fee”.  The Judge at first instance considered that payment premium could be characterised as a fee for a service i.e. making the advance available and is analogous to a commitment fee.

In the Court of Appeal, Tael argued that although the premium did not fall within the main interest allocation provisions, condition 11.9 Allocation of Interest and Fees (now condition 15.9) created an extra entitlement that included the premium i.e. if a fee had not accrued by the settlement date, but accrued at a later time while being referable to a period before the settlement date, such fee was payable by the buyer to the seller. 

Longmore LJ rejected that argument, noting that condition 11.9 did not use the words “shall pay”, “payment”, “be payable” or “paid” but instead uses the phrase “shall be for the account of”.  This wording indicated that its purpose was to describe how sums payable (under other conditions such as settled without accrued interest or trades flat) should be dealt with.  It did not create an extra entitlement for the seller to be paid further amounts by the buyer after the settlement date.

A Recurring or Non-Recurring Fee?  

The question for these purposes is whether the premium is “expressed to accrue by reference to time elapsed” and therefore a Recurring Fee.  The payment premium was found to accrue on a specific event (repayment or prepayment in full of the facility) and it was only the quantum of premium that was determined by reference to the lapse of time.

The Supreme Court (overturning the Court of Appeal’s decision on this point) confirmed that, while it is true that a period of time enters into the calculation of the amount of the payment premium, the entitlement to a payment premium under the facility agreement accrued on a defined event.

The Judgment continues to provide that the purpose of the premium is to reward the lender for the borrower’s use of the money over a period of time, but that does not mean that the premium is “expressed to accrue by reference to the lapse of time”.1

Although there is an argument that part of the premium relates to the period prior to the settlement date, that does not mean that the premium can be regarded, retrospectively, as having notionally accrued over that period. The calculation of the quantum of the premium should not be confused with the accrual of the right to the premium.  Following this analysis, a premium would not fall within the definition of a Recurring Fee and would therefore be akin to a Non-Recurring Fee.

Recent secondary loan market examples of “premium”  

We have seen some debate in recent months as to how “premium” clauses are intended to operate under German law governed loan agreements.  Under the German Civil Code, a lender and a borrower may not agree on compound interest in advance.  The prohibition of compound interest means that payments in kind (“PIK”) as typically provided for in English law mezzanine instruments are, under German law, not enforceable, and structures that aim to achieve the same result as a PIK structure have to be tested against the question of whether they constitute a circumvention of the prohibition of compound interest and are therefore not enforceable.

One way of addressing this prohibition is including the provision for “premium” which is often drafted as a one-off fee due to the lenders upon final repayment or prepayment in full of the relevant facility.  At that point, it provides for the payment of a premium and such interest accrued at the premium rate will not be added to the principal during the term of the loan. 

Prior to the Tael case, some counterparties were treating premium as PIK interest.  As such they were accounting for it as part of the Traded Portion up to the Trade Date as if capitalised and payable at the purchase rate by the Buyer on the Settlement Date.  The Supreme Court Judgment now clarifies that it is to be treated as a Non-Recurring Fee under the LMA Terms and Conditions and is therefore for the account of the Buyer.

Conclusion  

The fact that a dispute regarding the secondary loan market standard terms can ascend to the UK Supreme Court reinforces the position that the LMA Terms and Conditions are only a start point for negotiation and may not adequately address all economic or other rights of the seller and buyer in relation to a particular credit agreement.

Following the Tael Judgment, the LMA Secondary Documentation Committee is considering revising the standard terms and conditions to expressly include provisions for “premium”.  Until then, to avoid any misunderstanding, if you are trading a loan with premium, better to be explicit regarding the parties’ expectations at the time of trade.