A recent High Court case (Fairhold Securitisation Limited v Clifden IOM No 1 Ltd) has affirmed that in debt issuances involving a trustee, noteholders have only limited rights to take direct enforcement action. The case confirmed that:

  • trustees do not need to act on holders’ instructions until holdings have been verified;
  • on receipt of instructions, a trustee is not bound to act until it has had a reasonable time to verify holdings, review instructions, take advice and obtain satisfactory indemnification;
  • where a trustee holding a floating charge is obliged to take enforcement action, its failure to do so does not entitle noteholders to step into the shoes of the trustee and appoint administrators.

Market participants will recall the Fairhold securitisation which was in the courts earlier this year (see previous briefing here). In a further twist involving the same transaction, the English High Court was recently asked to consider the standing of an investor who purported to take enforcement action in the name of the trustee where it claimed the trustee had failed to do so. The judgment will be of interest to trustees, issuers and investors in providing some clarity on the ability (or otherwise) of investors to take action where a trustee does not act. The case highlights some of the limitations on investors taking direct action. It provides useful guidance on what constitutes “a reasonable period” of time before a trustee becomes bound to act in accordance with a noteholder direction, as well as the direct rights that noteholders may acquire where the trustee fails to act.

Facts and background

The application to court was made by Fairhold Securitisation Limited (the “Issuer“), who had issued notes (the “Notes“) as part of a securitisation transaction. It sought declarations that the appointments of administrators over it were void and that Clifden IOM No.1 Limited (“Clifden“), a purported noteholder and one of the respondents in the proceedings, was not the authorised agent of GLAS Trust Corporation Limited (the “Note Trustee“) to make such appointments or for any other purpose. The Note Trustee joined the Issuer as an applicant in proceedings.

The case relates to a securitisation transaction backed by cash flows from a portfolio of sheltered housing units. The Issuer’s payment obligations under the Notes were secured by fixed charges and a floating charge over all its assets in favour of the Note Trustee.

The portfolio failed to perform as expected. A series of payment defaults occurred with respect to interest due on the Notes and on 15 October 2017, the Issuer failed to repay principal on the Notes. Each of these was a Note Event of Default.

In early 2018, Clifden executed trades to purchase £141,700,000 of Class A Notes and £18,500,000 of Class B Notes (the “Trades“). The settlement of the Trades would have given Clifden a sufficient holding of Class A Notes to direct the Note Trustee to serve an enforcement notice on the Issuer and to enforce the security. However, Clifden failed to transfer funds to complete the Trades and subsequently the sellers informed Clifden that it was in breach and that this discharged them from completing the Trades. During the settlement period for the Trades, Clifden had also launched a cash tender offer for all Class A and Class B notes (the “Tender“). As a result of the Trades and the Tender, Clifden claimed to hold the necessary percentage of Notes, and subsequently directed the Trustee to enforce the security.

The transaction documents contained relatively standard enforcement provisions, under which the Note Trustee was not “bound to take any…proceedings, action or steps” to enforce the security unless “directed to do so by an extraordinary resolution of the Class A noteholders or the Class B noteholders or in writing by at least 25% in aggregate of the principal amount outstanding of the Class A notes or the Class B notes then outstanding” and indemnified and/or secured to its satisfaction. The conditions of the Notes provided that no noteholder was entitled to “proceed directly against the Issuer…or to enforce the Issuer Security unless the Note Trustee, having become bound to do so, fails to do so within a reasonable period and such failure is continuing“.

On 12 July 2018, Clifden filed notice of the appointment of administrators over the Issuer under paragraph 14(1) of Schedule B1 to the Insolvency Act 1986 (which grants power of appointment to the holder of a qualifying floating charge). On the same day, Clifden directed the Trustee to commence enforcement action.

The issues

Entitlement to give direction

The Issuer and the Note Trustee contended that Clifden did not hold the Notes and was not entitled to give directions to the Note Trustee to enforce the security. Clifden contested this and argued that, as a result of the Trades and the Tender, it held £276 million of the Notes. However, Judge Kramer was “struck by the lack of documentary support for these very substantial trades” and commented that Clifden had not provided the Note Trustee with evidence of its holdings. He held that it was not realistically arguable that Clifden could claim to own any of the Notes and therefore they were not entitled to give directions to the Note Trustee to enforce the security or to step into the shoes of the Note Trustee if it failed to act. Whilst it must be obvious that in order to direct the Note Trustee as noteholders, Clifden needed to actually be Noteholders, the case is helpful in affirming that a trustee is not obliged to act on directions until it has received proof of holding. Although the judge’s ruling on this matter effectively concluded the dispute on the facts, he went on to examine the merits of the legal arguments around the legitimacy of direct noteholder action had Clifden in fact been able to establish satisfactory proof of holding.

Implied Terms

Clifden argued that a term should be implied that where the Note Trustee has not taken enforcement action “within a reasonable period” following direction, the directing noteholder can act in the name of the Note Trustee and can appoint an administrator. Clifden contended that without implying this term, the noteholders would have a right of enforcement without a suitable remedy.

The judge held that Clifden’s argument for an implied term failed “both on its facts and in law“. This was because: (i) the transaction documents provided that only the Note Trustee had the discretion whether to bring proceedings against the Issuer; (ii) the Note Trustee was the only person who had the legal title to enforce the security; and (iii) a remedy was in fact open to an instructing noteholder in the event that the Note Trustee was “recalcitrant“. Remedial options available would have included (1) an application to court for directions requiring the Note Trustee to act on the instruction; (2) replacing the Note Trustee or (3) as an ordinary creditor of the Issuer, making an application to the court to appoint an administrator under paragraphs 2(a) and 10 of Schedule B1 of the Insolvency Act 1986. The judge indicated that such a noteholder would “fall into the position of the ordinary creditor who can proceed directly against the borrower” but “that does not mean that they then are entitled to do so in the name of the trustee“.

For these reasons, the judge contended that the contract worked “perfectly satisfactorily without the implication of such a term“.

“Reasonable period” to act on a noteholder direction

Leaving aside the question of Clifden’s holding of Notes, the judge went on to consider whether it had given the Note Trustee “a reasonable period” of time to act on their direction. The court’s commentary is helpful guidance for trustees when determining how swiftly they may be expected to act following receipt of instructions. Judge Kramer commented that “24 hours is unlikely to be long enough for the Note Trustee to weigh up the options, take advice, investigate the indemnity; and…investigate whether they were actually dealing with somebody who is entitled to give a direction at all“. In fact, Clifden had filed the notice of appointment of administrators (the “Appointment Notice“) at court at 1.44pm on 12 July but only delivered the instruction to enforce to the Note Trustee after business hours that same day. The filing of the Appointment Notice had thus preceded the delivery of the noteholder direction and so in this case the Note Trustee had been given “a negative time to respond“. The Note Trustee had not at the time of the filing of the Appointment Notice become obliged to act on the direction and so no direct rights of enforcement had fallen on Clifden (or any noteholder).

Appointment of Administrators

The judge also addressed a dispute between the proposed administrators and Clifden as to whether the administrators had consented to their appointment. The judge found against Clifden’s arguments that the administrators had consented to being appointed. Kramer J concluded by saying “We therefore have an appointment by somebody who had no power to appoint and administrators who did not consent to act. So the appointment was totally flawed and . . . is void.”

Trustee take-aways

This case provides useful clarity for trustees, issuers and investors. It echoes many of the principles that the Court of Appeal set out in their decision in Elektrim SA v Vivendi Holdings 1 Corp [2008] EWCA Civ 1178, including that no-action clauses should not be given “a wide or purposive meaning” when they “could sensibly be given their literal meaning“. The judgment is a reminder that the courts are unlikely to accept arguments seeking to imply terms or to assert rights that enable holders to circumvent the trustee in order to take direct enforcement action against an issuer. This is consistent with the view that the primary purpose of no-action clauses note issuance documents is to ensure that all noteholders act through the trustee to prevent multiple actions being brought by different beneficiaries. Faced with a recalcitrant trustee, a noteholder has a suite of options available to it, including an application to court for directions, replacing the trustee or taking enforcement action in its capacity as an ordinary creditor.

Trustees will also be pleased to see the courts recognising that a period of time is required for the trustee to consider a noteholder direction, obtain indemnification and investigate creditworthiness, review the required proof of holding and take any appropriate legal advice on any enforcement action. Although no guidance was given as to how much time a trustee would be afforded, it is notable that in this case the judge felt that 24 hours was not sufficient.