On the 11th of March 2015, The Supreme Court of the United Kingdom found that a prepayment premium (sometimes referred to as a make- whole payment), paid after the settlement date of a secondary loan trade documented under the Loan Market Association standard terms and conditions for par trade transactions (the LMA Standard Terms), is entirely for the benefit of the new lender and should not be apportioned amongst previous holders of the corresponding loan interest. Accordingly, a seller of loans should factor into the purchase price any future prepayment premiums or similar fees due (or potentially due) under the credit agreement or otherwise clearly state their allocation in the trading documentation.
Tael One Partners Limited (Tael) challenged the Court of Appeal’s decision that they were not entitled to receive part of a prepayment premium (a fee payable by the borrower upon an early prepayment of a loan).
Tael participated in a syndicated loan, the terms of which required a fee to be paid by the borrower to the lenders upon early prepayment of the loan. Under those terms, the fee was to be calculated by reference to the period from the effective date of the loan up to the date of prepayment. Following syndication, Tael sold part of its exposure under the loan to Morgan Stanley & Co International PLC (Morgan Stanley) using the LMA Standard Terms. The documentation between Tael and Morgan Stanley, including the pricing letter, did not contemplate any payment in relation to the prepayment premium. Some months after the trade had settled, the borrower prepaid the loan in full and paid the prepayment premium to the lenders at that time.
Tael asserted that, in accordance with the LMA Standard Terms, Morgan Stanley should have paid Tael the portion of the prepayment premium that had accrued prior to the date upon which the sale of the loan to Morgan Stanley was completed (the Settlement Date). In particular, Tael relied upon Condition 11.9(a) of the LMA Standard Terms which provides that:
“any interest or fees…which are expressed to accrue by reference to the lapse of time shall, to the extent they accrue in the period before (and not including the Settlement Date), be for the account of the Seller…” (emphasis added) Tael argued that the phrase “expressed to accrue by reference to the lapse of time” meant “calculated by reference to the lapse of time” and a portion of the prepayment premium should therefore be paid to Tael for the period prior to the Settlement Date.
THE SUPREME COURT DECISION
The Supreme Court unanimously dismissed Tael’s appeal. In the judgment, Lord Reed stated, “What appears to be clear…is that it [the prepayment premium] is not, ‘expressed to accrue by reference to the lapse of time’” as Tael argued but instead “accrues on a defined event”, namely, when the prepayment actually occurs. Lord Reed queried why, when a loan may be traded many times over its lifetime, the LMA Standard Terms would infer a term creating a right of the seller to a potential payment at any point over a substantial period of time. Unless the seller remains a lender, there is no mechanism under the LMA Standard Terms for the seller to know when such a right had crystallised. Lord Reed observed that, “It would be more natural to expect the potential value of the right to receive the prepayment premium to be reflected in the consideration for which the loan was transferred.”
Following the judgment of the Supreme Court, under the LMA Standard Terms, the recipient of a prepayment premium is entitled to take the full benefit of such payments. Therefore, participants in the secondary loan market should ensure that, when selling a loan, the purchase price allows for the potential benefit to the buyer of the right to receive any such future payments. Alternatively, parties may vary the rule by their express contractual terms provided they clearly state how the benefit of a prepayment premium will be allocated between seller and buyer under the trading documentation (i.e., the trade confirmation).