- Separate loan note holders treated as separate classes
- Consequently, no implied term of good faith either for issuer or alleged “majority” note holder
- Where contractual right of issuer involves a binary choice (amend/not amend), also no implied term of good faith
Vendor loan notes (“VLNs”) are a common feature of private equity transactions allowing a flexible method of deferring consideration otherwise payable for the target company. They will normally sit towards the bottom of the priority pile – ranking behind the claims of those providing the financing package for the acquisition. VLNs will sometimes rank ahead of notes in favour of those providing the equity element of the financing for the deal although this is not universally the case. The terms of the VLNs are subject to negotiation in each case and the strength of the protection afforded by the VLNs often depends considerably on the reasons why part of the consideration is left outstanding.
A recent case has shown how considerable care is needed when negotiating provisions in the financing package or in the inter creditor documents regulating the rights of different participants and allowing for postponement of claims based upon one or more majority of creditors being obtained.
Although there is sometimes said to be an equitable rule that a majority of creditors who exercise voting rights may not unfairly impose their will upon a minority – who vote against a particular proposal – this rule is extremely limited in scope. It should not be regarded as a substitute by those taking VLNs to express contractual protections by way of delimiting a set of restricted matters which can only be forced through by a unanimous vote. Giving someone a unilateral right to alter maturity of a VLN for example is a recipe for disaster.
The claimants (“C”) sold their shares in Swift Advances plc to Kestrel Acquisitions (“D1”). Part of the consideration for the acquisition was the issue of vendor loan notes (“VLNs”) by D1 to C. In order to fund the acquisition, D1 also issued discounted loan notes (“DLNs”) to its shareholders (“D2”). Following financial difficulties, D1 issued further follow on notes to D2 (“FONs”).
On each issue of FONs, repayment of the VLNs were subordinated and the redemption date postponed pursuant to a unilateral right granted to D1 under the VLNs to modify the VLNs to ensure consistency with the DLNs. The DLNs were similarly amended.
C claimed that this was in breach of D1’s and D2’s obligation of good faith, which was to be implied to protect C as a minority within a larger single class (being holders of both the VLNs and DLNs) and/or that as D1 was exercising a contractual discretion, a similar term should be implied.
The court rejected C’s claim holding that (amongst other things):
- the holders of the VLNs and DLNs did not constitute a single class – they were two separate classes, whose rights were separately documented;
- there was no discretion on D1 in the sense of choosing from a range of options – the only option was to amend to ensure consistency with the DLNs. Consequently, there was no requirement of good faith.
England is one of the few jurisdictions which has proved hostile towards implying a general duty of good faith into commercial contracts. It has generally only allowed parties to contracts to recover where there has been some misrepresentation. Some recent statements have suggested the traditional hostility of the English judiciary to implied duties of good faith in commercial contracts is on the wane. In particular in Yam Seng v International Trade Corporation the judge had this to say:
“I respectfully suggest that the traditional English hostility towards a doctrine of good faith in the performance of contracts, to the extent that it still persists, is misplaced.”
The Myers decision suggests that there is still some way to go before the court’s reluctance to imply a good faith obligation into a contract other than in narrow and established circumstances extends to this type of financing transaction.
The full case transcript can be found here: Myers v Kestrel Acquisitions Limited.