The English High Court’s first decision on CMBS Class X Notes

We now have the English High Court’s first judgment concerning the position of Class X Notes in a CMBS structure. The rights of the Class X Notes in the Windermere VII CMBS were considered by the Court in Hayfin Opal Luxco 3 S.A.R.L v Windermere VII CMBS plc (2016).

The judgment (handed down on 8 April 2016) deals with a number of issues, some of which were fact specific and some have wider relevance. The position taken by the Court on the consequence, under the Events of Default, of interest underpaid as a result of miscalculations in the past, is among the issues that stand out for Corporate Trustees and Cash Managers. The judge had already decided that there had been no historic underpayment of Class X interest so his comments on this aspect were obiter.

If the Court had decided that an Event of Default had occurred then the Class X Noteholder as holder also of over 25% of the Class B Notes then outstanding, now the most senior class of Regular Notes, would have been able to compel acceleration of the Notes and therefore bring into play the Post-Enforcement Priority of Payments. That waterfall was particularly advantageous for the Class X Noteholder since it placed the Class X Note at the top of the waterfall, followed by the Class B Notes. Further, if the Class X Noteholder was successful on the amount of its claims the consequence would be that there might be nothing left for the other Noteholders.

The Class X Noteholder pointed to the Event of Default in Condition 10(a)(i) of the Notes, which provided that (inter alia) a failure to make a payment of interest for five days on the most Senior Class of Notes then outstanding (now the Class X Note) was an Event of Default. However, Condition 5(d) required the Cash Manager to determine and notify the Issuer, the Trustee and the Paying Agents of the interest payable on the Class X Notes. The judge agreed with the Issuer that no monies were payable unless and until the Cash Manager had made that determination. Accordingly, since the Cash Manager’s determinations would not have included any higher amounts now alleged to have been miscalculated, the judge ruled that those higher amounts never in fact actually became due and payable. The judge said: “The Conditions provide an elaborate mechanism for the determination and publication of the amounts which will become due and payable on the Notes. Important consequences (such as the occurrence of Events of Default) attach to timely and precise compliance with payment obligations under the Notes, and hence it is consistent with the overall CMBS structure that the payment obligations of the Issuer in respect of the Notes should be defined by those determinations.” The judge went on to say that the effect of the Conditions of the Notes was that the only amounts in respect of Class X interest that became due and payable on each Payment Date were those determined to be due and payable by the Cash Manager, so that “even if it might now be appreciated that there had been a miscalculation and underpayment of a Class X Interest Amount…that would not have been an Event of Default in respect of the Notes.

The judge’s final comment on this aspect of the case was unambiguous: “Standing back, it seems to me that this is an entirely sensible commercial view of the Conditions, and that Hayfin’s interpretation is without commercial merit. Given the hugely significant consequences for all parties of the occurrence of a Note Event of Default, I simply cannot see why, at the commencement of the CMBS structure, the parties should be taken to have intended to create what could amount to a concealed “hair trigger”, under which an Event of Default could accidentally occur because of a simple miscalculation of the amount of interest payable, without that fact being appreciated by anyone, and then be incapable of cure at a later date when it was discovered, no matter how solvent the structure might be.

The Court’s position is yet another example of the sensible and commercial approach which has been demonstrated by the English Courts in a number of recent cases concerning complex financial transactions. In that connection, it is worth noting that this was a decision of the recently introduced Financial List division of the High Court, established in October 2015.

Permission to appeal to the Court of Appeal has been granted. If that appeal takes place, it will be interesting to hear what the Court of Appeal has to say on the judge’s rulings.