Hot on the heels of a number of recent cases on the interpretation of securitisation documents1 comes Cheyne Capital (Management) UK (LLP) v. Deutsche Trustee Company Limited and another. In this case the Court of Appeal judges unanimously agreed on the "natural and ordinary" meaning of a clause in dispute, upholding the High Court's decision. As David Cohen explains, like the recent Supreme Court case of Arnold v. Britton, this case is a reminder that the courts are reluctant to depart from the literal meaning of words on a page.

The relevant clause appeared in an issuer servicing agreement in a securitisation transaction. It stated that no termination of the special servicer was to take effect unless:

"… the Rating Agencies have confirmed to the Issuer Security Trustee and the Note Trustee that the appointment of the successor [Servicer] or [Special Servicer] will not result in an Adverse Rating Event, unless each class of Noteholders have approved the successor [Servicer] or successor [Special Servicer], as applicable, by Extraordinary Resolution". (Clause 26.4(b)).

Cheyne was operating adviser to the controlling class of noteholders. In this capacity it asked the issuer of the notes and the note trustee to appoint a replacement special servicer. However, it was not possible to get a confirmation from one of the specified rating agencies, Fitch, on whether appointment of the proposed successor special servicer would result in an "Adverse Rating Event". This was because Fitch had adopted a policy stance in December 2012 not to provide these types of rating confirmation. The parties disagreed on the implications of this.

Cheyne argued that the relevant clause should be interpreted as requiring confirmation only from those rating agencies that were willing in principle to give it. Therefore, because Fitch was not, the absence of a confirmation from Fitch should not prevent the replacement of the special servicer.

The trustee, however, contended that Clause 26.4(b) should be interpreted as requiring confirmation from all three rating agencies. Therefore, the absence of a confirmation from Fitch did prevent the replacement of the special servicer without noteholder approval.

The basic rules of contractual interpretation

In any case involving contractual interpretation the basic aim of the court will always be to decide what a reasonable person would have understood the contracting parties to have agreed. To achieve this aim, the English courts apply some basic principles:

  • Principle 1: The language of the document, given its natural and ordinary meaning, must always be the starting point for interpreting contractual terms. However, the full "matrix of facts" is relevant for ascertaining the meaning of that language.
  • Principle 2: If the meaning of the language in the document is unclear, the court will usually prefer the interpretation that is most consistent with business common sense.
  • Principle 3: If the literal meaning of the language gives an absurd result, so that it is obvious something has gone wrong with the drafting, the court will look through that literal meaning if it is clear what a reasonable person would have understood the parties to have meant.

Although these principles are clear and well established, they do not necessarily provide predictable conclusions to disputes about contractual interpretation. These disputes often hinge on whether either of Principles 2 and 3 above has been engaged. Parties, and judges, often take differing views on this.

Application of the principles

In a pithy judgment the Court of Appeal sided with the trustee, and dismissed the appeal. It decided that the "natural and ordinary" meaning of the words in Clause 26.4(b) of the issuer servicing agreement was "clear and unambiguous". In particular, the natural and ordinary meaning did not permit the failure of one or more rating agencies to provide a confirmation to be ignored merely because the rating agency or agencies in question did not provide the confirmations as a matter of principle. Principle 2 above was therefore not engaged.

The court also concluded that the natural and ordinary meaning of the words "does not produce a commercially absurd result and is not inherently inconsistent with commercial common sense". Principle 3 above was therefore also not engaged. In particular, the court was happy that the exception "unless each class of Noteholders have approved the successor … Issuer Special Servicer … by Extraordinary Resolution" avoided the natural and ordinary meaning of the words giving an absurd result. The exception covered the situation where a rating agency had indicated that it would not give confirmations at all as a matter of principle, just as much as where it refused to give a confirmation. The court accepted that it might be difficult to secure the approval of the more senior classes of noteholder, or that one noteholder class might be able to block a change required by the controlling class. However, that didn't mean that giving the relevant wording its natural and ordinary meaning produced a commercially absurd result.

All cases involving contractual interpretation will involve a detailed review of the particular wording. The same factual background may impact on two differently worded contracts in wildly different ways. In this case Cheyne had tried to use a High Court decision (US Bank Trustees Limited v. Titan Europe 2007-1 (NHP)) in support of its arguments. The US Bank v. Titan case had also looked at the failure of a rating agency to provide a rating agency confirmation on the replacement of a special servicer. However, in US Bank v. Titan, the court read and construed the relevant contractual provision as though the rating agency confirmation was not required. As the Court of Appeal pointed out, there were material differences between the two documents in the two cases. Therefore, the views expressed by the judge in US Bank v. Titan did not help on the point in issue.