In one of the most eagerly awaited appeals to affect the restructuring and insolvency community since MyTravel, the Court of Appeal in the European Directories case ruled on Friday 22 October that:

  • The courts should take a commercial construction of the release clause and not allow junior creditors to circumvent their subordinated status by making technical arguments on the construction of these clauses.
  • The Second Lien Lenders could not come up with any sensible commercial explanation for their construction of the release clause, other than that it gave them a ransom position.
  • The natural way to read the language of the release clause was to give it a wider interpretation than simply being limited to the Obligor being disposed of and its holding company.
  • Commercially it made no sense to require a disposal of the group on a company-by-company basis in order to restructure or sell it as a going concern to a third party purchaser. Disposing of the group on a company-by-company basis, whilst theoretically possible, would be complicated, futile, costly and not what the draftsman of the release clause would have intended.


In the first instance judgement, Mrs Justice Proudman held that the wording of the release clause in the European Directories intercreditor agreement only entitled the security agent to release the security granted and the debt owed by the Obligor being sold and its holding company — it did not, according to the first instance judge, allow a release of the security granted and debt/guarantor obligations due from the subsidiaries of that Obligor. If that was right it effectively ruled out a hostile pre-pack by the senior lenders around the subordinated creditors.

The Court of Appeal has now reversed that judgement and potentially avoided the reopening of several restructurings which have been concluded on documentation containing similar clauses.

However, this may not be the final word on the matter — although the Court of Appeal refused leave to appeal to the Supreme Court, the junior creditors still have 28 days from the date of the Court of Appeal decision in which to petition the Supreme Court directly for leave to appeal. It is unclear at this stage whether the junior creditors intend to do so.

Release Clauses and the Implementation of Restructurings

The vast majority of non-consensual restructurings (i.e., where agreement is not reached with at least one key stakeholder in the capital structure) in the current market environment involve the enforcement of a share pledge over a holding company (the Holdco) or other transaction security initiated by the senior (or “in the money”) creditors. The shares in Holdco are then typically sold to a third-party purchaser or, more frequently, to a new company (Newco) controlled by the senior (or “in the money”) creditors.

It is essential to be able to deliver Holdco and all of its subsidiaries (the Group) in such a way that there is a “clean break” from the old structure. This requires that Holdco and the entire Group are comprehensively released from all “out of the money”debt, including especially second lien and mezzanine debt, all guarantees of such debt and all shareholder/structural/investor/inter-company debt, along with a release of all security provided for such debt.

Unlike the US, where such releases are provided as part of the Chapter 11 process, in most English law-governed European restructurings (which take place outside a formal process) the “clean break” and release is delivered by the Intercreditor Agreement and specifically the powers granted to the Security Agent by the release clause. Since February 2009, the market has had the benefit of the Loan Market Association’s standard Intercreditor Agreement, but prior to this intercreditor terms and particularly the release provisions varied significantly.

Any ambiguity in the drafting of the release mechanics could be exploited by the junior creditors, particularly if they were otherwise stoodstill and “out of the money”, in an attempt to gain leverage for themselves in the restructuring negotiations by claiming that the senior lenders could not conclude the restructuring around them. As a result, in many recent restructurings the release mechanisms contained in the Intercreditor Agreement have come under intense scrutiny, with lawyers seeking out drafting ambiguities or uncertainties in the negotiated arrangements which could be exploited to give their clients a better seat at the table.

What is clear from the Court of Appeal decision in European Directories is that a commercial rather than an overly technical approach needs to be taken when construing these clauses. The subtext to this is that the court will not be impressed by the arguments of junior subordinated creditors seeking to adopt a technical approach in order to give themselves a ransom or hold out value. That was clear in the approach taken by the court last year in IMO Car Wash regarding the valuation of junior creditors’ claims and is echoed in the Court of Appeal decision in European Directories regarding the construction of release clauses.

European Directories

The European Directories case involved a pre-LMA intercreditor agreement in which the Security Agent was authorised upon an enforcement sale to execute:

“if the asset which is disposed of consists of all of the shares (which are held by an Obligor…) in the capital of an Obligor or any holding company of that Obligor, any release of the Obligor or holding company from all liabilities it may have to any Lender, Subordinated Creditor or other Obligor, both actual and contingent in its capacity as guarantor or borrower (including any liability to any other Obligor by way of guarantee, contribution, subrogation or indemnity and including any guarantee or liability arising under or in respect of the Senior Finance Documents or Mezzanine Finance Documents) and a release of any Transaction Security granted by that Obligor or holding company over any of its assets under any of the Security Documents”.

If this clause only allowed a release of the company being sold and its holding company, then it would not release the borrowing/guarantor liabilities of the subsidiaries lower down the corporate structure and in particular at the operating company level. It would be necessary to have a series of multijurisdictional enforcements which, as restructurings such as Nybron have demonstrated, may be completely impractical in some cases, and will at a minimum bring greater cost and delay to the process. The Court of Appeal in European Directories has confirmed that a commonsense and commercial interpretation should be preferred and (subject to any last minute appeal by the subordinated creditors to the Supreme Court) closes off an avenue for subordinated creditors to gain leverage in the restructuring negotiations by finding technical defects in the intercreditor documentation that are inconsistent with the discernable commercial intent.

Legal Analysis

The English courts have, in recent years, moved away from adopting the literal or “natural” meaning of contractual wording when that would conflict with commercial common sense. In Manni Investment v Eagle Star [1997] AC 759 Lord Steyne said that the words should be interpreted in the way in which a reasonable commercial person would construe them. According to him, that standard was “hostile to technical interpretations and undue emphasis on niceties of language”. The same judge confirmed in a 2004 case (Sirius International Insurance v FAI [2004] 1 WLR 3251) that there had been “a shift from literal methods of interpretation towards a more commercial approach”.

The issue came before the new Supreme Court in 2009 in the SIV restructuring case of Re Sigma Finance Corporation [2009] UKSC 2 (1). The disputed clause in Sigma said that “During the Realisation Period the Security Trustee shall so far as possible discharge on the due dates therefore any Short Term Liabilities falling due for payment during such period”. The question was whether the assets were to be distributed according to the dates when the relevant debts became due or on a pari passu basis. The lower courts found in favour of the pay-as-you-go interpretation.

However, the Supreme Court overturned the decision. They criticised the lower courts for attaching too much weight to the “natural meaning” of the words and too little weight to “the context in which that sentence appears and to the scheme of the Security Trust Deed as a whole”. This represented a firm rejection of the literal approach and Lord Collins said that “an instrument securing commercial obligations” should not be subjected to the type of textual analysis more appropriate to tax legislation which had been scrutinised through many committee stages.