UK: Beneficial Interests in Loan Agreements

The question of beneficial interests in rights under loan agreements has been considered recently by the English courts in two different contexts. In both cases the underlying transactions involved comparatively familiar structures – secondary market debt trading and conduit lending to take advantage of double tax agreements. However, both decisions highlight the need to consider carefully the operation of "boilerplate" provisions in the light of actual circumstances.

The decisions were made by the Commercial Court in Barbados Trust Co Ltd v (1) Bank of Zambia (2) Bank of America N.A. (2006) and by the Court of Appeal in Indofood International Finance Ltd v JP Morgan Chase Bank N.A. (2006). In the first case, the claimant was unsuccessful. Although it had a beneficial interest, it could not make a direct claim for payment because of the terms of an assignment provision in a loan agreement. In the second case, the appellant was successful. It was not a beneficial owner of interest under a loan agreement for the purposes of a double tax agreement and so it could take advantage of a redemption provision in its loan notes.

The Barbados Trust case related to an oil import facility which had been made available by a syndicate of banks to the Bank of Zambia, the borrower. The agreement was governed by English law. It provided that a bank’s rights could be assigned only to another bank or financial institution with the prior written consent of the borrower, such consent not to be unreasonably withheld and to be deemed to have been given if the borrower did not reply to a request for consent within 15 days of its receipt.

Bank of America had taken an assignment of part of the rights under the agreement by means of the standard terms of the Emerging Market Traders Association ("EMTA") and had simultaneously assigned those rights to a third party, again on EMTA terms. There had been subsequent assignments, ultimately to Barbados Trust. Bank of Zambia did not expressly consent to any of them and, as only Bank of America was a "bank or financial institution", its deemed consent only applied to the initial assignment. In view of this, Bank of America had executed a declaration of trust in respect of the relevant rights under the loan agreement in favour of Barbados Trust.

In this case, Barbados Trust was claiming unpaid principal and interest from the borrower because Bank of America had declined to act as claimant. However, the claims of Barbados Trust were dependent on the validity of the assignment to Bank of America and the effectiveness of its declaration of trust.

The judgment contains an interesting analysis of the effect of the EMTA terms in these circumstances since they did not expressly deal with the concept of "deemed" consent by the borrower to an assignment and the assignment was expressed to be effective before the prior written consent of the borrower could have been obtained. However, the Court decided that the assignment took effect to complete the transfer of rights to Bank of America on receipt of the actual or deemed consent, so that the consent could properly be treated as given prior to the assignment. If it had not, then the substitute or unwind provisions under the EMTA terms would have come into effect.

However, Barbados Trust was less successful in relation to the declaration of trust. It was not a bank or financial institution so it could not take an assignment and enforce its claims directly against the borrower, given the terms of the assignment provision. As a result, the Court held that Barbados Trust could not make a direct claim against the borrower as a beneficiary under the declaration of trust because that would achieve a result which would be inconsistent with the terms of the loan agreement.

The Indofood case related to a more complex original financing structure. Indofood International Finance Ltd, a Mauritian company, was the issuer of loan notes governed by English law which were guaranteed by its Indonesian parent company. The proceeds of the loan notes were lent by the issuer to its parent under a separate loan agreement governed by Indonesian law. The parent was obliged to pay interest under that agreement to the issuer in time to allow the issuer to pay interest to its noteholders - but in practice the parent had effectively paid interest direct. This structure enabled the parent to take advantage of the Indonesia/Mauritius double tax agreement, reducing its liability to withhold tax from the interest to 10 per cent (rather than the standard rate of 20 per cent).

The note conditions provided that the notes could be redeemed by the issuer early if there was a change in Indonesian law whereby the obligation of the parent to deduct withholding tax exceeded 10 per cent, unless that more onerous obligation could be avoided by the issuer "taking reasonable measures available to it".

Indonesia had given notice to terminate its double tax agreement with Mauritius and as a result the issuer had given notice to redeem the notes. However, a previous court decision had held that the issuer was not entitled to redeem them because it could assign the loan agreement to a new Dutch Company which could take advantage of the Indonesia/Netherlands double tax agreement to reduce the withholding tax deductible by the parent to 10 per cent or less. In this case the issuer was appealing against that previous decision.

The Court held that the first question to be determined was whether, on the balance of probabilities, there were any measures available to the issuer or the parent whereby the obligation to pay withholding tax in excess of 10 per cent could be avoided. If such a measure existed, then the question would arise as to whether it was in all the circumstances reasonable to require them to take it.

However, an essential condition for the application of the Indonesia/Netherlands double tax agreement was that the new Dutch company should be the "beneficial owner" of the interest paid or payable by the parent. The Court held that, in the context of a double tax agreement, this term had to be given an international fiscal meaning, not derived from the domestic laws of the contracting states. The concept of "beneficial owner" was inconsistent with that of a formal owner who did not have the full privilege directly to benefit from the income. The legal, commercial and practical structure behind the loan notes meant that the issuer or the new Dutch company (if it took an assignment of the loan agreement) could not enjoy such a privilege. Neither of them would derive any direct benefit from the interest payable by the parent - they would just be administrators of that income.

Therefore, the interposition of a new Dutch company was not a measure available to the issuer or the parent to avoid the obligation to pay an increased rate of income tax. It could not in all the circumstances be reasonable to require them to implement it, since that would be likely to lead to a dispute with the Indonesian tax authorities that the parent would be unlikely to win. Accordingly, the issuer was entitled to redeem the notes. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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