CLO Securitisation: English Court Applies Established Approach in Dispute Over Collateral Manager’s Fee

The English courts will adopt a commercial approach to resolving contract disputes where traded instruments are involved, as shown by a recent English case involving commercial contracts of particular interest to the CLO market, Deutsche Trustee Company Limited v Duchess VI CLO B.V. [2019] EWHC 778.

The case concerned the construction of transaction documents relating to a European collateralised loan obligation securitisation transaction that was set up in 2006. It provides an interesting illustration of the application of the principles formulated in previous cases. The court’s emphasis on certainty and predictability will be particularly reassuring to those engaged in this market.

Background to the Case

In 2018, the Class F noteholders voted to redeem the Class F notes (the equity tranche under the CLO securitisation). The collateral manager claimed, under the terms of the Collateral Management Agreement, to be entitled to an Incentive Collateral Management Fee (ICM Fee) upon the note redemption.

The Class F noteholders disputed this and the trustee (Deutsche Trustee Company Limited) sought directions from the court in Part 8 proceedings. In the meantime, the trustee, which was neutral as to the outcome of the case, held the monies representing the ICM Fee pending the determination of the court. The principal protagonists were joined into the proceedings and it was accordingly left to the collateral manager and one of the Class F noteholders (representing all the Class F noteholders) to make the substantive arguments.

As far as the collateral manager was concerned, the interpretation of the Class F noteholders “would enable the Class F Noteholders to avoid payment of an [ICM Fee] wholly unjustifiably”, and for which there was no commercial rationale. The Class F noteholders’ position was that it was never intended that an ICM Fee would be paid on such a redemption, that the ICM Fee was an ongoing incentive payment intended to reflect the achievement of the performance target of an IRR exceeding 10% over the life of the Class F notes.

The Court’s Approach

The High Court looked to recent decisions of the English Supreme Court involving the interpretation of contracts, including Re Sigma Finance Corp [2010] 1 All ER 571 and Rainy Sky v Kookmin Bank [2011] 1 WLR 2900, and said: “This is a case where the language of the Transaction documents is clear in the context of the transaction, applying the iterative approach recommended in Sigma and in Rainy Sky [the iterative process “involves checking each of the rival meanings against other provisions of the document and investigating its commercial consequences”]. Commercial parties buying into such traded instruments expect to be bound by the language of them. They are entitled to the certainty and predictability that the adoption of a proper contextual interpretation of the language produces”.

The latter point reflected the Supreme Court in Sigma “to the effect that the words used have a particular, even paramount, importance when the court is considering a traded instrument which will exist for a long time and pass through many hands”, so that “the matrix of fact ought only to be relevant in the most generalised way”.

In the view of the court, the transaction documents read as a whole were unambiguous on the main point at issue, and no ICM Fee was payable to the collateral manager as a result of the redemption of the Class F notes. The court then considered whether the commercial background and the relevant factual matrix known to all the parties at the date of the transaction pointed towards a different interpretation. The judge did not find much assistance from the evidence of the background: “I can quite understand both sides of the debate”.

Neither of the expectations of the collateral manager or the Class F noteholders was “inconsistent with the interpretation that I have concluded is the clear meaning of the words used”. Also, the Class F notes had not performed well: “I cannot see how it can be said to be unjust or unexpected that the Collateral Manager should not be rewarded…”.

The judge pointed out that had the notes performed well, it would have been in the interests of the Class F noteholders “to stick with it” and pay the quarterly ICM Fee “rather than forcing a redemption just in order to deprive the Collateral Manager of” an ICM Fee, which the collateral manager had argued was the “perverse incentive” if the Class F noteholders’ interpretation succeeded.