In Napier Park European Credit Opportunities Fund v Harbourmaster Pro-Rate CLO 2 BV(1) the appellants, junior noteholders of notes secured on a collateralised loan obligation (CLO), appealed a first-instance decision relating to the interpretation of reinvestment criteria in a collateral management agreement.

The dispute arose from a number of notes issued by Harbourmaster in 2006, which were secured on the proceeds of a CLO. In the usual way, there were various classes of note and payments arising from the notes were made in a waterfall, with first payments made to senior noteholders and any remainder being made to mezzanine and junior noteholders.

The question was whether certain sums (termed 'unscheduled principal payments') were available to be distributed to investors or should be reinvested. The junior noteholders argued that the sums should be reinvested. The senior noteholders, on the other hand, would have benefited from a distribution and argued that the moneys should have been distributed.

Whether the unscheduled principal payments could be reinvested turned on the interpretation of the reinvestment criteria, one requirement of which was that the senior notes "have not been downgraded below their Initial Ratings". In February 2010 the notes were downgraded by Standard & Poor's from AAA to AA, but in November 2012 were upgraded back to AAA. The unscheduled principal payments were not reinvested because the administrator decided that the reinvestment criteria had not been, and could not be, satisfied.

At first instance, the court agreed. It found that the reinvestment criteria were clear and unambiguous: as the senior notes had been downgraded in the past, the reinvestment criteria could not be satisfied. That decision left the junior noteholders with no benefit from the notes.


On appeal, the junior noteholders argued that at first instance the court had taken too narrow and too literal an approach to the words in the reinvestment criteria.

The court had applied a number of rules of construction, which of themselves were not contentious:

  • The overriding objective of the interpretation of a contract is to ascertain the meaning which the document would convey to a reasonable person having all the background knowledge reasonably available to the parties at the time of the contract.
  • In carrying out this exercise, the starting point is the ordinary, natural and grammatical sense of the language used in its context. Where it is clear that the parties have adopted a specialist vocabulary, the starting point is the ordinary meaning of those specialist terms.
  • Where the language is ambiguous in its context, the interpretation most consistent with business common sense (ie, the commercial purpose of the transaction) is to be preferred.
  • Where it is clear that a mistake has been made in the language and it is clear what a reasonable person would have understood the parties to have meant, the contract must be interpreted in accordance with that meaning.
  • If the words used are unambiguous and it cannot be said that something has gone wrong with the language, the court must apply the unambiguous meaning, even if some other interpretation would be more commercial – the fact that it is a poor bargain for one of the parties is insufficient to introduce another meaning.

The junior noteholders argued that the lower court's approach artificially separated the linguistic and grammatical construction of the reinvestment criteria from the commercial purpose of the agreement. In this case, as a matter of grammar, the words used were capable of more than one meaning: they could mean that the notes either had never been downgraded or are not presently downgraded even though they had been in the past, as had occurred in this case. Once such alternative interpretations arose, the junior noteholders argued, the court was required to take an iterative approach and test the various interpretations against one another.

This followed from the Supreme Court decision in Re Sigma Finance Corp(2) (another case involving financial instruments), in which the court set out that the issue of interpretation involved an iterative process, checking rival meanings against one other. This process involves checking not only the grammatical interpretations, but also the commercial consequences of those interpretations: commercial considerations are not simply a 'safety valve' where one particular interpretation is commercially absurd, but are an inherent part of the construction process.

In the present case, the Court of Appeal found that commercial considerations weighed in favour of the junior noteholders' interpretation. The court noted that a historic downgrade did not amount to a breach of other investment criteria that had applied earlier in the fundraising process, and queried why it should therefore amount to a breach now. It concluded that the purpose of the provision was to protect the senior noteholders by requiring proceeds from repayment of the underlying loans to be used to redeem the notes where the senior noteholders were at risk following a downgrade. As the notes had been upgraded, again, that risk was no greater than at the start of the transaction. Accordingly, the court could see no commercial reason why the senior noteholders required additional protection.

On this basis, the Court of Appeal overturned the first-instance decision and found in favour of the junior noteholders.


Following recent Supreme Court decisions in Re Sigma Finance and Rainy Sky SA v Kookmin Bank,(3) the principles governing contractual interpretation under English law are reasonably well established. The difficulty comes, as in this case, in applying them to particular factual situations.

It is clear from this decision that commercial considerations should infuse any discussion of contractual interpretation and are not simply a bolt-on or cross-check to be applied at the end of the process. Understanding the underlying transaction thus becomes essential in arriving at the correct construction: it is clear that, while the court acknowledges that it must be wary of knowing what is or is not commercially sensible, it will not be fearful of discerning that commercial intent from the contract in front of it and applying it in a robust way.

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(1) [2014] EWCA Civ 984.

(2) [2009] UKSC 2.

(3) [2011] UKSC 50.