Court of Appeal revisits interpretation of Lloyds enhanced capital notes and confirms approach to correcting mistakes.

In the June 2015 issue of the Banking and Finance Journal, we commented on the High Court's decision in BNY Mellon Corporate Trustee Services Limited v LBG Capital No 1 Plc & another, in which it was held that LBG was not entitled to redeem enhanced capital notes ("ECNs") early. At the end of 2015, LBG's appeal of that decision was allowed, and the Court of Appeal held that early redemption is in fact possible.


This case relates to £3.3billion of ECNs issued by Lloyds Bank subsidiaries ("LBG") in 2009. The ECNs were designed to increase Lloyds' core tier 1 capital ("CT1 Capital") after the FSA found that it had a shortfall. More detail of the factual background can be found in the June 2015 Banking and Finance Journal article. In brief, the ECNs had maturity dates from 2019-2032 and a very high interest rate prior to maturity. The trust deed constituting them allowed for early redemption on a "Capital Disqualification Event" ("CDE"). The definition of a CDE (the "CDE Definition") included a situation where the ECNs ceased to be "taken into account" for the purposes of a stress test.

In carrying out a stress test in December 2014 (the "December Stress Test"), the PRA did not take the ECNs into account. LBG announced that a CDE had occurred and it intended to redeem them. BNY Mellon, the trustee of the ECNs, issued proceedings to prevent an early redemption. In June 2015 the High Court found that no CDE had occurred. LBG appealed.


The primary legal issues on appeal were:

  1. Whether the December Stress Test was relevant for the purposes of the CDE Definition, even though it related to Common Equity Tier 1 Capital, whereas the CDE definition referred only to stress tests in respect of Consolidated CT1 Capital (the "preliminary issue").
  2. Whether the High Court was correct to conclude that a CDE would only occur where there was a "disallowance in principle" of the use of ECNs in connection with stress testing (the "main construction issue").  

The Court of Appeal agreed with the High Court in relation to the Preliminary Issue. By the time of the December Stress Test, due to regulatory changes, CT1 Capital was a historical concept. A literal reading of the CDE Definition would mean that the CDE Definition would never be met. The judge held that this was an obvious drafting mistake, that it would have been obvious to reasonable addressees of the ECNs (even though many of them were retail investors) and that it was appropriate to correct it.

LBG's appeal was allowed as regards the main construction issue. The Judge held that the ECNs would cease to be "taken into account" for the purpose of the CDE Definition if they were no longer capable of contributing to LBG's ability to meet the stress test's requirements. Since the ECNs were first issued, their conversion trigger point had fallen below the regulatory minimum ratio. This meant that they could not assist LBG in meeting capital requirements, were not taken into account in the December Stress Test and would not be taken into account in future stress tests. The Judge held that a CDE had occurred and the ECNs could be redeemed early.


The Court's approach to the issue of contractual interpretation is of interest as it demonstrated very clearly that it was less interested in the strict technicalities of drafting and more interested in a purposive approach bringing commercial sense to the contract.

The Court's finding in respect of the reasonable addressees' understanding of the ECNs is also of practical interest. The Court noted that the ECNs were highly complex instruments, and their offer memorandum made it clear that the decision to invest should only be taken after informed and detailed consideration. The reasonable addressee must therefore be taken to be someone with an informed understanding of the working of financial markets, the regulatory background and the use of stress tests. It is clear that Courts will be unsympathetic to retail investors arguing that they would not have understood an obvious error in the drafting of documents in circumstances where clear warnings had been given, pre-investment, regarding the complexity of the transaction and the need for a detailed risk assessment to be carried out.