A recent decision (heard in the Financial List) in Hayfin Opal Luxco 3 S.A.R.L. & Anor v Windermere VII CMBS plc & Ors [2016] EWHC 782 (Ch), relating to the interpretation of commercial mortgage backed securitisation ("CMBS") documentation, will be of interest to finance lawyers and banking litigators alike.

The decision concerns the calculation of interest payable on certain ‘Class X’ notes. Whilst the findings relate to the specific documentation in question, they may well be of wider market significance given that such instruments are commonly used in CMBS structures and have (particularly in respect of those issued prior to the global financial crisis) been somewhat controversial. In particular, the Court confirmed that:

  1. interest payable to the Class X noteholder did not increase to include any default interest payable by the borrower under one of the underlying loans;
  2. interest payable to the Class X noteholder did not include interest on an underlying loan that had been capitalised;
  3. unpaid interest on the Class X note itself did not accrue interest (although this element of the decision was obiter).

Indeed, the first point above on default interest has also recently been considered in Credit Suisse Asset Management LLC v Titan Europe 2006-1 plc & Ors [2016] EWHC 969 (Ch), in which the Chancellor of the High Court reached the same conclusion in respect of a different set of Class X notes and underlying loan documentation. Whilst the specific analysis of the contractual wording was therefore also different, the same outcome was reached on the basis of an interpretation that was most likely to carry the commercial outcome intended by the parties given the overall scheme of the notes.

This judgment also provides guidance as to the approach to interpreting contracts governing complex financial instruments more generally. The case confirms (in line with previous Court of Appeal authority), that the Court will be reluctant to depart from the plain language used in an agreement unless the provision is ambiguous.

Permission to appeal has been granted and the appeal is due to be heard in early 2017.


The case concerned the rights attaching to a Class X note, issued as part of a CMBS structure arranged by Lehman Brothers International (Europe) called ‘Windermere VII’ (the “Class X Note”).

As is common in a CMBS structure, a special purpose vehicle was established to issue notes of various classes, in this case Windermere VII CMBS plc (the “Issuer”). The payment of interest and principal on the notes was funded through payments of interest and principal on a portfolio of underlying loans secured against commercial real estate.

Interest on the notes was - in respect of all but the Class X Note - calculated by reference to EURIBOR (with an additional margin reflecting the seniority of the relevant note). In respect of the Class X Note, the Issuer did not pay a conventional rate of interest. Rather, the noteholder would receive any excess interest which the Issuer could expect to earn from the underlying loans, over and above the amounts that the Issuer was obliged to pay in respect of (a) the other notes; and (b) certain other fees and costs associated with the CMBS structure (the “Class X Interest Rate”).

Among the mortgage loans acquired by the Issuer was part of a loan made by Lehman Brothers Bankhaus AG (the “Nordostpark Loan”). The principal due on this loan was not repaid on the loan maturity date in 2012, constituting an ‘Event of Default’. The claimants, two related companies collectively referred to as “Hayfin” or the “Class X Noteholder”, subsequently acquired the Class X Note (and the Class B Notes) in 2015. Since acquiring its interest, Hayfin advanced a number of arguments as to how the amounts payable on the Class X Note should have been calculated and contended that the amounts paid by the Issuer were inadequate.


Hayfin issued a Part 8 Claim in the Financial List to determine a number of issues as to the rights attaching to the Class X Note. Four of these issues are of particular interest and are described in more detail below.

(1) Was interest paid to the Class X Noteholder improperly calculated by reference to EURIBOR?

The first issue was whether interest payable on the Class X Note ought, as a matter of construction, to have been calculated by reference to EURIBOR, or to a fixed rate of interest. As explained above, because the rate of interest payable by the Issuer was dependent upon interest earned on underlying loans, it was necessary for the Court to consider a number of defined terms in the loan documentation and this issue therefore turned on the facts of the case. The Court followed the most recent authority of the higher courts on contractual interpretation and rejected Hayfin’s submission that the relevant definitions could be corrected by construction or by necessary implication by the addition of further words.

There was an interesting discussion as to whether the proposed additional words would amount to implication of terms into the agreement (the strict requirements for which are set out in the recent Supreme Court judgment in Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Ltd [2015] UKSC 72, see blog post) or be characterised as the process of correction of mistakes by construction referred to in Chartbrook Ltd v Persimmon Homes Ltd & Ors [2009] UKHL 38. The Court held that there were certain features common to both lines of authority and, on either view, the test that must be satisfied is a strict one. The Court will “only add words to the express terms of an agreement if it is necessary to do so because the agreement is incomplete or commercially incoherent without them”.

The Court further held that there was considerable force in the Issuer’s argument that the relevant definitions were not mere boilerplate, but carefully drafted and central to the commercial deal. It therefore accepted that the definitions were likely to have been given careful attention by the contracting parties: Arnold v Britton & Ors [2015] UKSC 36. Accordingly, the Court did not consider that there was any reason to alter the plain language used by the parties. Interestingly, the Court observed that there was a “premium” to be placed on the language used in commercial documents forming the basis of tradeable financial instruments, although the Court did not rely upon this premium in its decision.

(2) Should the interest paid to the Class X Noteholder have included default interest payable on the Nordostpark Loan?

The second issue was whether interest payable to Hayfin in respect of the Class X Note ought to include any default interest payable by the borrower under one of the underlying loans, the Nordostpark Loan (notwithstanding the fact that the borrower could not pay that default interest). This issue arose because the definition of ‘Expected Available Interest Collections’ in the conditions to the Class X Note, which determined the Class X Interest Rate, included an assumption that interest payable on the underlying loans had been paid in full. Accordingly, Hayfin argued that the Class X Interest Rate ought to have included any default interest payable on the Nordostpark Loan.

The Court accepted that the definition of Expected Available Interest Collections required an assumption that the borrower of the Nordostpark Loan had paid default interest. However, it was necessary to ask whether any such monies would actually become available to the Issuer under the loan documentation. Pursuant to this documentation, the clear intention and effect of the waterfall provisions was to subordinate the payment of default interest to the Issuer until any unpaid interest and principal was paid. Interest payable to the Class X Noteholder therefore did not include default interest, as such monies would not become available to the Issuer until the waterfall was paid in full.

(3) Should the interest payable to the Class X Noteholder have included interest on an underlying loan that had been capitalised?

The Court was asked to determine the effect of capitalising interest paid on an underlying loan (the “Adductor Loan”) on the calculation of interest payable to the Class X Noteholder. The loan agreement governing the Adductor Loan provided that interest would be capitalised where it had been due for at least one year. After capitalisation, this amount was not included by the Issuer in the cumulative interest due and payable under the Class X Note. Hayfin argued that this capitalisation of interest could not have been intended to adversely affect the Class X Noteholder.

The Court concluded that the Issuer was correct to reduce the interest payable to the Class X Noteholder because the capitalisation of interest was specifically allowed for in the loan agreement. The Court held that if it had been intended that the capitalisation of interest ought not to reduce the amount of interest payable to the Class X Noteholder, then that could have been spelt out in the documentation. This finding was notwithstanding the fact that the offering circular in relation to the Class X Note made no mention of the possibility that the Class X Interest Amount might be affected by any capitalisation of interest owing on an underlying loan.

(4) Did unpaid interest on the Class X Note itself attract interest?

The fourth issue of interest was whether unpaid interest on the Class X Note itself accrued interest, either at the same rate as the Class X Interest Rate, or at some lower rate. Hayfin relied upon a condition of the Class X Notes entitled ‘Deferral of Interest’. It contended that any failure to pay the correct Class X interest amount would give rise to a shortfall as defined in that condition, which would itself accrue interest at the Class X Interest Rate.

Given the Court’s conclusion that there had been no underpayment of interest, this issue did not fall strictly to be determined. However, the Court nevertheless expressed the view that unpaid interest did not attract interest at the Class X Interest Rate because:

  • The relevant provision of the Class X Note conditions did not provide a remedy for miscalculation and resultant underpayment of amounts due under the Notes. Rather, it provided a mechanism to address a situation where the Issuer suffered a cash-flow shortage and could not meet its obligations under the Notes. Only in the latter case would the unpaid amounts accrue interest under the provision.
  • Under the Note conditions, no money was payable until the cash manager had determined the amount of interest payable on the Class X Notes. Accordingly, until the cash manager had made such a determination, interest was not payable and could not itself accrue interest.

The Court also expressed its view on two alternative arguments raised by the Issuer. It rejected the Issuer’s argument that the parties could not have intended for unpaid interest on the Class X Note to accrue interest at the Class X Interest Rate (which was much higher than any normal commercial interest rate). On the other hand, the Court - while not finally determining the point - was minded to accept the Issuer’s argument that a requirement to pay interest at the Class X Interest Rate for unpaid interest on the Class X Note would be an unenforceable penalty.


This judgment represents a detailed and considered decision from the Financial List, further illustrating the current approach of the Court to contractual interpretation and providing guidance of wider market significance for the use of Class X notes in CMBS structures, as noted in the introduction.

Over and above the key takeaway points on the interpretation of Class X notes, the Court’s comments in relation to the penalty clause argument are noteworthy. The Supreme Court recently considered penalty clauses in detail in Cavendish Square Holding BV v Talal El Makdessi; ParkingEye Limited v Beavis [2015] UKSC 67 (see blog post). Under the new more flexible test as to whether or not a clause will be found to be penal (and therefore unenforceable), it is generally expected that there will be less interference in contracts by the Courts. Against this background, it is perhaps surprising that a Financial List judge was willing (albeit on an obiter basis) to find that the requirement to pay interest at the Class X Interest Rate would amount to an unenforceable penalty. Whilst the Court commented that the interest payable otherwise would have been “exorbitant (if not extortionate)”, it is a high bar for a clause to be found to be out of all proportion to the legitimate interest in enforcing the obligation under the contract, particularly where the contract has been carefully drafted and negotiated. It may be that the issue would have been treated differently if it had been determinative.