As was common at the time of the inception of the transaction, Danske Bank A/S (Danske) had provided a liquidity facility (LF) on a commercial mortgage-backed securitisation issued by the issuer, Gemini (Eclipse 2006-3) plc (Gemini). Due to the subsequent plethora of downgrades that have followed the financial crisis (from which the liquidity facility provider did not escape), a liquidity stand-by drawing of £64,000,000 was made by Gemini.
The liquidity facility provider was entitled under the liquidity facility to recover any increased costs as a result of the application of Basel II (as implemented in Denmark) to the LF. A subsequent withdrawal by Moody’s of the separate rating obtained in relation to the LF caused a rise in the increased costs due to Danske being required to set aside more capital for regulatory purposes.
Last week, the Commercial Court held that the increased costs of Danske above a certain threshold were not payable as they had not become due under the transaction documents. These costs would only become due when all higher ranking debts had been settled in accordance with the waterfall (and when there were funds available to settle the increased costs of just under £2 million).
In seeking to obtain judgment for payment of this amount, Danske unsuccessfully argued that an expenses drawing should have been made under the LF and used to settle the increased costs (which would thereby have made the amounts due). Mr Justice Cook agreed with Gemini’s argument that this was a “bootstraps” argument that “…amounted to saying that an Expenses Drawing had to be made for the Liquidity Subordinated Amounts, because, if it was made, then the Liquidity Subordinated amounts would be due and payable…” on the part of Danske and gave judgment for Gemini.
Whilst on its facts this decision is an interesting example of the kind of issues which can arise in regard to liquidity facility providers (see also the issues in the Titan Europe series – for example, Titan Europe 2006-2 PLC), it should be borne in mind that the liquidity facility structure and the fact pattern examined by the Court in this case is unusual (primarily because of the combined features of the subordinated liquidity amounts, expenses drawing provisions and the performance of the deal). It is therefore unlikely to be indicative of the way that the majority of liquidity facilities in the market operate. Indeed, as we are seeing in the variety of notices to the market about increased costs (for example, Windermere XIV CMBS Limited, Eurosail-UK 2007-2NP PLC and Eurosail 2006-4NP PLC), these are frequently payable at the top of the waterfall and provided for in very broad terms.
Moreover, given the current increase in capital costs applicable to such facilities, which are set to increase further after the introduction of Basel III, the provision of liquidity facilities has become increasingly unappealing to banks. Indeed, liquidity facilities in asset-backed securitisations are rapidly becoming an endangered species!
Nonetheless, while this decision may not be likely to be instructive for other transactions, it has the virtue of demonstrating that one cannot engineer technical arguments simply to circumvent the specific commercial goals underpinning a transaction of this type.
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