Subordination agreements are fundamental to the structuring of financings involving a senior lender and the holders of any other junior debt of a borrower. Most lenders who provide financing to a new borrower will routinely require that the prospective borrower’s shareholders, partners or other related parties who have advanced loans to the borrower subordinate the repayment and ranking of that indebtedness to the new lender’s debt. The express terms of that subordination, and any permitted payments, will vary deal by deal.
A recent decision of the Newfoundland Court of Appeal shows that despite any expectation of subordination, a borrower cannot compel a related party to enter into a form of subordination agreement with a senior lender in the absence of an express contractual provision calling for that subordination. In addition, the express contractual provision must be contained in an agreement signed by the related party. Furthermore, the Court concluded that a subsidiary cannot bind its parent corporation to deliver a subordination agreement except in very limited circumstances that did not apply in that case.
The facts in OCI LP were quite complicated and indeed there were several related court proceedings involving the parties and multiple contested issues. The case involved the interpretation of multiple formal agreements between the parties and certain of their affiliates. In very simplified terms, the relevant facts were as follows:
- The Borrower was a limited partnership and received junior loans from multiple related parties to assist in the acquisition of a fisheries operation, including a loan from an affiliate [Landvis Iceland] of one of its limited partners [Landvis Canada]. The loan was made pursuant to a formal subordinated loan agreement known as the LSLA.
- The Borrower also received senior bank financing for the acquisition, and Landvis Iceland voluntarily delivered a subordination agreement in respect of its junior loan to the senior lender, and then later to an assignee of the senior lender.
- The Borrower was subsequently arranging for new take-out financing by a new senior lender, but Landvis Iceland refused to provide a new subordination agreement in favour of the new senior lender.
- The Limited Partners had entered into a Unanimous Unitholders Agreement [UUA]. However, Landvis Iceland was not a party to the UUA. Rather it was Landvis Canada that had been established as a Limited Partner of the Borrower, and Landvis Canada was the contracting party to the UUA.
- The UUA included a covenant requiring the Limited Partners and their affiliates to provide a subordination of their loans to the original senior lender and in respect of any replacement financing.
- The LSLA did not, however, contain an express covenant requiring Landvis Iceland to subordinate its loans.
In interpreting multiple contracts together, the trial judge had determined that Landvis Iceland was not contractually obligated pursuant to either the UUA or the LSLA to execute and deliver a subordination agreement to the new senior lender. He found that Landvis Iceland had fulfilled its responsibilities by delivering the first two subordination agreements.
The Court of Appeal framed the issue before it as whether, when read together and in the factual context, the UUA and the LSLA required Landvis Iceland to subordinate its debt to the new senior lender. The Court agreed with the Borrower’s submissions that it made no sense in the context of the overall arrangements between the parties for the provisions of the LSLA to operate for two financings and no more. However, Justice Rowe writing for the unanimous Court concluded that:
- the LSLA did not actually establish an obligation for Landvis Iceland to subordinate its debt, but rather only dealt (in part) with how things operate if subordination has occurred.
- although the UUA contemplated that Landvis Iceland would subordinate its debt, it was not legally required to do so given that it was not a party to the UUA.
- Landvis Iceland had not been contractually obligated to deliver its first two subordination agreements, but rather had chosen to do so in light of the commercial realities at the relevant times. Despite this prior conduct, Landvis Iceland could not however be compelled to deliver a third subordination agreement.
Justice Rowe agreed with the trial judge’s conclusion that there was no known authority whereby a subsidiary could contractually bind its parent without the parent’s consent. Thus, by signing the UUA, Landvis Canada could not bind Landvis Iceland as an affiliate. After an examination of earlier authorities, the Court did not find that there existed a principled exception to the requirement for privity of contract.
Although the Court of Appeal’s ruling may appear to some to be very technical in nature despite professing to read together multiple agreements in a factual context, OCI LP shows the importance of matching obligations and covenants to the parties who need to provide them. Lenders should not assume that their borrowers will have the ability to compel related parties to deliver subordination agreements.