High Court decides sale proceeds in CMBS transaction should be characterised as "principal" rather than "interest" within the meaning of the relevant documentation 


In August 2006, Barclays Bank PLC ("Barclays") granted a loan of £918,862,500 ("the Loan") to a number of Guernsey registered limited partnerships which used the funds to refinance a portfolio of some 36 commercial properties in the UK valued at £1,143,335,000. It was intended that the income derived from the properties would service the commitment under the Loan.

In November 2006, Gemini (Eclipse 2006-3) Plc purchased the Loan and its security from Barclays and funded the purchase by issuing secured commercial mortgage floating-rate notes which fell due in July 2019 (the Notes). The Notes were sub-divided in to 5 classes (referred to as Class A through to Class E) ranking in that order of priority. The Loan was in fact payable three years earlier in July 2016 and provided for acceleration in the usual way dependent on the occurrence of certain events of default. CBRE Loan Servicing Limited ("CBRE") subsequently took an assignment and assumed the role of Master Servicer and Special Servicer of the Loan which included collecting monies due and enforcing security and allocating them appropriately.

Initially the rental income from the security was sufficient to pay the interest under the Loan and which in turn paid the interest under the Notes but by October 2009 the interest was no longer being paid in full and the value of the security declined. By March 2012, the value of the security had decreased to £437,500,000. The reduction in value and the failure to pay interest in full resulted in an event of default in relation to the Loan so that on 6 August 2012 the Loan was accelerated and the full amount became due and payable. The Notes however were not accelerated and interest remained payable pursuant to these each quarter.

Subsequently, administrators were appointed over the general partners of the borrowers in Guernsey and receivers were appointed in relation to the properties in England and Wales to collect the rental incomes and effect a sale of the security. CBRE also entered into a hedging agreement with Barclays whereby Barclays agreed not to terminate certain interest rate hedging transactions.

The Issue

In March 2014, proceedings were commenced by CBRE seeking a declaration as to how the sale proceeds and asset income should be characterised given that agreement could not be reached between the parties. Characterisation of the receipts determined the allocation of funds but the Cash Management Agreement was silent on treatment of rental income and sale proceeds (including premiums) and the terms "principal" and "interest" was not defined.

If the receipts were characterised as principal the Class A Noteholders' were entitled to the monies whereas it was in the interests of the other Noteholders that the sale proceeds be treated as interest.


Mr Justice Henderson found that the lack of definition of the terms "principal" and "interest" in the Loan documentation simply envisaged the application of common sense and that funds should be characterised according to their source. He noted that the funds "represent the realised capital value of a property which stands as security for the Loan”. Accordingly he held that sale proceeds should be treated as principal. As a result of this Judgment the Class A Noteholders were entitled to rank first, before other Noteholders.


Ambiguities and gaps in contractual documents can prove an expensive distraction when large sums of money are left to the courts to decide for the parties. Whilst the outcome of this case may seem to be nothing more than the application of common sense, it highlights the risks that can arise when contracts leave undefined certain aspects of construction, in this case the treatment of and distribution of sale proceeds to different ranking noteholders.