Key Point

The Court of Appeal has held that once a ratings downgrade provision - amending waterfall payments and the ability to reinvest portfolio proceeds - in a structured financing has been triggered it can be reset if the relevant rating is later reinstated to the required level.

The facts

The parties entered into a collateralised loan obligation (CLO) transaction under which 14 classes of notes in the principal sum of €602 million were issued. There were senior and junior ranking notes. The documents contained provisions relating to the use of unscheduled repayments of principal on the underlying loans and in particular whether these were to be used to repay the senior notes or reinvested in the CLO by purchasing new underlying loans which would hopefully benefit all note holders including the junior note holders.

Whether or not certain Reinvestment Criteria as defined in the CLO documents were met depended in part on:

"the ratings on [senior notes] have not been downgraded below their Initial Ratings".

On 5th February 2010 those notes were downgraded by S&P to AA from the original AAA rating. On 30th November 2012 the same notes were rerated by S&P restoring the AAA rating. In early 2014 an issue arose between senior and junior note holders as to whether proceeds should be reinvested or had to be paid out under the contractual waterfall to meet the claims of the senior note holders. The outcome depended on whether the Reinvestment Criteria was capable of being satisfied after the downgrade by S&P in 2010.

The junior creditors argued the Reinvestment Criteria was satisfied because at the time the decision came to be made by the note trustee whether to reinvest or pay out under the waterfall the notes had the same rating as the Initial Rating. The senior note holders argued the Reinvestment Criteria could never be satisfied once the initial AAA rating was lost in 2010.


The Court of Appeal overturned the first instance decision which had held that the Reinvestment Criteria could not be satisfied if a downgrading of the relevant notes had happened at any time after the inception of the deal.


The High Court thought this was a case in which the document was clear and unambiguous. That Court refused to redraft the clause by adding the words "or they have subsequently been re-graded to at least their Initial Ratings". Reading that judgment you would not have held out a lot of hope for a success on appeal.

The Court of Appeal was persuaded by the silky oratory of Richard Miles QC for the junior note holders that it should not be "beguiled by [an] initial impression or to limit the process of interpretation to purely linguistic points, but to delve deeper into the landscape of the transaction as a whole". That is exactly what the Court of Appeal did and it decided that given the obvious purpose of the test and the context in which it was used the trigger could be reset allowing the Reinvestment Criteria to be satisfied if the Initial Rating of the senior notes had been restored by the time the decision to reinvest had to be made by the trustee. 

The reason the Court of Appeal was prepared to embark on their deep legal dive into the transaction was they were persuaded (where the Chancellor at first instance was not) that the words the parties had used were capable of two meanings at least. Each of the meanings made some grammatical sense but produced wholly different commercial results. In the face of that conundrum the only way to sort the matter out was for the Court of Appeal to adopt an iterative approach to the construction of the clause testing rival arguments not just against other terms in the contracts but also against the commercial consequences flowing from the rival contentions. It goes without saying better to have made the point clear on the documents on the original drafts - but a skilfully engineered escape for the junior note holders nevertheless

Napier Park Credit Opportunities Fund Limited v Harbourmaster Pro-Rata CLO BV