The Supreme Court has held, by a majority of 3:2, that LBG's enhanced capital notes ("ECNs") can be redeemed early. Lord Neuberger agreed with the Court of Appeal's pragmatic approach to contractual interpretation, but found it a difficult decision, and was not surprised that the first instance Judge (and indeed some members of the Supreme Court itself) had different views.
We commented on the High Court's decision in this case in the June 2015 issue of the Banking and Finance Journal, and on LBG's successful appeal to the Court of Appeal in the January 2016 issue. Detail of the background can be found in those articles. In brief, the case relates to £3.3 billion of ECNs issued by Lloyds Bank subsidiaries ("LBG") in 2009. The ECNs were designed to increase Lloyds' core tier 1 capital ("CT1 Capital") after the FSA had found it had a shortfall. They had maturity dates from 2019-2032 and a very high interest rate (over 10%) prior to maturity. The trust deed constituting them provided for early redemption on a "Capital Disqualification Event" ("CDE"). The definition of a CDE (the "CDE Definition") included a situation where the ECNs "ceased to be taken into account" for the purposes of a stress test.
The PRA carried out a stress test in December 2014 (the "December Stress Test"). In doing so it did not take the ECNs into account. LBG announced that a CDE had occurred. BNY Mellon, the trustee of the ECNs, disagreed and issued proceedings to prevent early redemption. In June 2015 the High Court found that no CDE had occurred, meaning that LBG was not entitled to redeem the ECNs. In December 2015, the Court of Appeal allowed LBG's appeal, holding that the notes were redeemable. BNY Mellon appealed to the Supreme Court.
BNY Mellon raised two arguments. The first was that the December Stress test was not relevant for the purposes of the CDE Definition because it related to Common Equity Tier 1 Capital, whereas the CDE Definition referred specifically to Consolidated CT1 Capital. This argument was dealt with swiftly by the Supreme Court, which had "no hesitation in agreeing" with both the High Court and the Court of Appeal that the reference to Consolidated CT1 Capital in the CDE Definition should be interpreted as a reference to that type of capital or "its then regulatory equivalent".
The second argument raised by BNY Mellon was more difficult for the Supreme Court to resolve. It suggested that the fact that the ECNs were not taken into account as a matter of fact in the December Stress Test was not enough to trigger a CDE, and that the ECNs must be "disallowed in principle" from being taken into account before the CDE Definition could be invoked. LBG's position was that it was sufficient that changes in regulatory capital requirements meant that the ECNs could no longer assist LBG in passing the December Stress Test. This was because the ECNs' conversion trigger (i.e. the point at which they would be converted to common equity) was much lower than the minimum level required by the PRA. Lloyds would have had to fail the stress test by a wide margin before the ECNs could be of any assistance.
The majority of the Supreme Court agreed with LBG, and held that a CDE had occurred. The ECNs could not be taken into account "to do the very job for which their convertibility was … designed". That conclusion was supported by the contrast between the wording "ceased to be taken into account", and different wording "no longer eligible to qualify" found elsewhere in the Trust Deed. The Court also noted that if BNY Mellon's interpretation was favoured, it would be very difficult to envisage a situation in which the CDE Definition could ever be invoked. Lord Neuberger said "the notion that fully paid up share capital could ever be excluded from the definition of Tier 1 Capital…seems fanciful".
The Supreme Court was split on the second argument raised by BNY Mellon, and Lord Neuberger considered that it was a difficult question to resolve. The majority in the Supreme Court supported a pragmatic, purposive approach to the interpretation of the CDE Definition, but the divided opinion of the Judges not only in the Supreme Court, but also at first instance and in the Court of Appeal, highlights how difficult questions of contractual interpretation can be. This is a reminder to parties (if one were needed) of the importance of making sure the wording of contractual terms is as clear as possible so as to avoid disputes as to their meaning in the future.