UK: Court Rules That Prepayment Indemnity Does Not Extend To Future Losses

Last Updated: 16 July 2012
Article by John Naccarato and Laura Sealey

Summary

In K/S Preston Street v Santander (UK) plc [2012] EWHC 1633 (Ch), the High Court considered a borrower indemnity in respect of prepayment of a term loan and held that the indemnity only extended to losses incurred as at the date of demand under the indemnity and not to future losses.

Case facts

K/S Preston Street (the "Claimant") entered into a 10 year term loan agreement dated 11 February 2004 with Allied & Leicester Commercial Bank plc, which was then subsequently assigned to Santander (UK) plc (the "Defendant"). The key indemnity clause of the loan agreement was as follows:

"Clause 6.2 (Interest): In addition to any prepayment costs payable under para.9, the partnership shall indemnify the bank on demand against any cost, loss, expenses or liability (including loss of profit and opportunity costs) which the bank incurs as a result of the repayment of the loan during the fixed rate period or any further period during which the rate of interest applicable to the loan is fixed."

Clause 9 expressly stated that the partnership could prepay the loan in whole or in part in advance of the final repayment date, subject to payment of certain hedging early termination fees and payment of a prepayment fee specified as a percentage of the loan, decreasing yearly until year 6 where no prepayment fee was payable.

In September 2011, the Claimant prepaid the loan in full. The Defendant sought payment for both its incurred losses and its future losses as a result of such prepayment. The Claimant disputed that it was liable for such losses.

Issues

The two issues to be resolved by the court were: (a) whether, as a matter of construction, the Defendant was entitled to recover any sums pursuant to the indemnity in Clause 6.2 as a result of the prepayment; and (b) if so, whether the indemnity in Clause 6.2 only covered losses incurred as at the date of prepayment or whether it extended to future losses too.

Claimant's argument

The Claimant argued that due to the use of the word 'repayment' in Clause 6.2, the indemnity could not apply to a prepayment.  The correct clause to ascertain the amount to be paid upon a prepayment was Clause 9 and therefore, as the prepayment would occur after year 6, no fee was payable.

Defendant's argument

The Defendant argued that, pursuant to Clause 6.2, it was entitled to claim for its past and future losses resulting from the prepayment. When calculating its loss pursuant to Clause 6.2, the Defendant explained that due to its lending policy it would not be possible for the prepaid amount to be lent to another commercial non-bank borrower but that it would be possible to re-lend the repaid money on the interbank market (which would earn a much lower rate of interest).  The Defendant clamed that Clause 6.2 entitled it to recover its future losses, being the difference between the interest that it would have earned on the Claimant's loan and the interest that it could charge upon an interbank loan.

Decision

The Judge considered Clause 6.2 to be unambiguous and noted that the indemnity contained therein was expressly stated to be "in addition to..." the prepayment fees payable pursuant to Clause 9 and therefore was intended to apply to the same event to which Clause 9 applied. Therefore, the Claimant failed in its argument that Clause 6.2 could not apply to a prepayment. The use of the word 'repayment' did not negate this conclusion as the word 'repayment' was used in different ways throughout the loan agreement.

The Judge concluded that Clause 6.2 did not allow the Defendant to recover its future losses as the use of the word "indemnify" within Clause 6.2 suggests that the Claimant must indemnify the Defendant for crystallised liabilities that fall within the class "cost, loss, expenses or liability". Therefore, for the Defendant to be indemnified in respect of an expense that expense must have been incurred and not a future loss. This was supported by both: (i) the use of the wording "incurs" within Clause 6.2, as if it was intended for Clause 6.2 to extend to future losses the Clause would instead contain the wording "incurs or to be incurred"; and (ii) the fact that the Defendant only became entitled to the indemnity "on demand" as the Judge found it difficult to see how the Claimant could indemnify the Defendant on demand against a loss that, as at the time of that demand, has not been incurred.

In addition, the Judge noted that the loan agreement expressly permitted prepayment in Clause 9 and therefore the issue was not a breach of contract claim. The consequence of this was that the normal assessment as to what future losses might reasonably be, as would be undertaken when assessing damages for breach of contract, could not apply. The Judge did suggest that it would have been possible to draft to provide for the indemnity to cover future losses, for example by including a table or formula from which any repayment of sums for future loss could have been easily derived without any possibility of argument between the parties.

Comment

This case serves as a warning to ensure that the wording of a prepayment indemnity clause clearly and unambiguously reflects the true commercial intention of the parties to the loan agreement. The case demonstrates the court's reluctance to allow future losses other than when assessing damages for breach of contract. Therefore, if it is intended that future losses should be covered by the indemnity, this should be set out in clear unequivocal language by reference to some pre-determined and indisputable method for valuing such future loss.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 11/07/2012.

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