The High Court has recently given judgment in a case* relating to the duties owed by a security trustee to mezzanine lenders, in circumstances where the security trustee is enforcing security on behalf of senior lenders. The judgment of Mr Justice Eder contains a number of significant issues, of which security trustees should be aware. However, this judgment will be noteworthy for anyone operating in the leveraged finance sector.

The case related to a restructuring of the "Stabilus" group of companies in early 2010. Stabilus is in the business of supplying parts to the automotive industry. It had been the subject of private equity acquisitions, which had left it highly leveraged. The relationships between the senior and mezzanine lenders were regulated by an English law intercreditor agreement ("ICA"). The security was held in a security trust, by a security trustee appointed under the ICA.

In early 2010, Stabilus was under a great deal of financial pressure and some 4 months later, it owed around €409 million to the Senior Lenders and €83 million to the mezzanine lenders. The mezzanine debt was under water and it became clear that steps had to be taken to avoid the entry of Stabilus into an insolvency regime. Accordingly, the senior lenders instigated a restructuring in April 2010, but they did so without the consent of the mezzanine lenders. The mezzanine lenders contended that this action was unauthorised and an improper use of the ICA. Hence, a dispute arose between senior lenders and mezzanine lenders, which resulted in the security trustee being caught in the middle of the competing factions.

JP Morgan Europe Limited ("JPME") was the security trustee, the senior facility agent and the mezzanine facility agent. Another member of the JP Morgan group, JP Morgan Chase Bank ("JPMCB"), was one of the senior lenders. In addition to considering the duties of a security trustee, the court was asked to determine whether JPME and JPMCB had adequately separated their roles and whether JPME acted inappropriately in failing to put in place chinese walls and in sharing information with senior lenders to the exclusion of the mezzanine lenders.

The implementation of the restructuring was backed by all of the senior lenders, thereby requiring JPME, under the terms of the ICA, to enter into a transaction whereby the operating subsidiaries of the Stabilus group were sold to SPVs owned by the senior lenders. Notwithstanding the fact that the mezzanine lenders had not provided consent to the restructuring, the backing of all the senior lenders was sufficient to permit JPME to take this action. The mezzanine lenders received nothing, as the assets to which they would otherwise have had recourse had been transferred away to the SPVs. The mezzanine lenders challenged the validity of the restructuring on a number of grounds and the court was therefore asked to consider, inter alia, whether JPME had complied with (a) its fiduciary duties as security trustee and (b) the duties it owed under the ICA. The mezzanine lenders also advanced claims for damages or equitable compensation.

The court held that the restructuring was valid. The court decided that it was possible for a person to be in a fiduciary position in relation only to parts of his activities. The mezzanine lenders' contention, that JPME was a fiduciary in relation to the enforcement of the security and therefore obliged to act in the interests of all the lenders (including the mezzanine lenders), was not correct. The court held that the ICA set out the scope and nature of JPME's enforcement duties and the ICA stipulated that JPME's only duty to the mezzanine lenders in relation to a sale was equivalent to that of a mortgagee to a mortgagor. This was not a fiduciary duty.

The only obligation on the security trustee, (in the ICA or at law) on how to conduct the sale process was to obtain the fair market value in the prevailing circumstances and to exercise the power of sale for its proper purpose. This was said to be analogous to the duties of a mortgagee. Indeed, it was made clear that JPME had no positive duty to exercise its powers and had complete discretion as to the timing of a sale; it was not obliged to delay a sale in the hope of achieving a higher offer at some point in the future, which would benefit the mezzanine lenders.

The court did consider that JPME and JPMCB had failed to separate their roles effectively and that JPME acted improperly by failing to put in place chinese walls and by sharing information with senior lenders. However, the Eder J did not regard such conduct as causing any associated loss.

The decision is a valuable reminder that where the mezzanine debt is "under water", the contractual documents may not afford the mezzanine lenders any influence over the way in which security is enforced and value realised.