UK: When Can A Note Trustee Lawfully Adopt Expenses Incurred By Noteholders?

UBS AG, London Branch v. GLAS Trust Corporation Ltd. and another [2017] EWHC 1788 (Comm)

A securitisation transaction took place in 2006, the subject of which was cashflows generated by a portfolio of sheltered housing. Such cashflows were to be used by the issuer of the notes in this case (the Notes) to repay its debts to the holders of the Notes (the Noteholders). The cashflows were also to be used in order to meet any payments due to UBS and another entity (together, the Issuer Swap Counterparties). Such payments arose as a result of swaps entered into by UBS and the issuer as part of the overall transaction. Cashflows generated by the portfolio became insufficient to pay both the Issuer Swap Counterparties and the Noteholders, who effectively became competing creditors. UBS terminated the swaps in October 2015, the termination amount being almost £312 million.

At around the same time:

  • an ad hoc group of the Noteholders (referred to throughout the judgment as the AHG) replaced the original note trustee with GLAS Trust Corporation Ltd. (the Note Trustee), apparently on the basis that it would be more "proactive";
  • the issuer failed to pay the interest due on the Notes; and
  • the Note Trustee directed the cash manager not to make payments under the swaps. 

In August 2016, the issuer purported to rescind the UBS swaps on the basis of alleged fraudulent misrepresentations (which UBS denies), but no proceedings were started in that regard. The parties have also been considering a restructuring of the transaction since 2015.

The AHG, in the meantime, had instructed Freshfields and N.M. Rothschild & Sons Ltd (together the AHG Advisers). Their combined fees for the year March 2015 to March 2016 were approximately £2.5 million (the AHG expenses). In March 2016, the Noteholders passed an Extraordinary Resolution to "authorise and direct the Note Trustee to execute a Fee Letter" with the AHG Advisers so as to pay the AHG expenses "as an expense of the Note Trustee which will be provided for and reimbursed by the Issuer to the Note Trustee..." As well as paying the fees already incurred, the Note Trustee proposed to pay the AHG Advisers for their work after March 2016 (which, in the case of Rothschild, included a £75,000 per month retainer and a £3.75 million transaction success fee). The AHG Advisers were not advising on the swaps dispute.

UBS argued that the Note Trustee had no power to incur and claim reimbursement of these costs. The practical significance for UBS was that, as would be expected, the transaction documents provided for a pre-enforcement payments waterfall. In that waterfall, UBS ranked above the Noteholders, but below the Note Trustee's right to recover its expenses. UBS took the view that the AHG was effectively trying to jump the queue, by getting the Note Trustee to pay for its advice.

The issue was one of construction – under the relevant clauses of the Issuer Deed of Charge (IDC) and the Note Trust Deed (NTD), the issuer was obliged to pay for certain costs properly incurred by the Note Trustee. The obligation arose in relation to all "legal fees" and "other costs, charges, liabilities, damages and expenses" which had properly been incurred by the Note Trustee in relation to four broadly described categories of activity by the Note Trustee. UBS disputed whether the fees of the AHG Advisers came within the scope of such clauses.

The judge described clauses dealing with trustees' expenses as typically widely drafted and to be given a "commercial and not artificially restricted meaning... This reflects the fact that the exercise of the trustee's powers may contain a substantial measure of judgement, may be controversial, and may have to be carried out speedily to enable resolution of the transaction. Of course, the position depends on the construction of the particular clause, but subject to that, the trustee should be able to fulfil its duties with confidence that if it acts in a commercially reasonable manner, it will be entitled to indemnification".

Having said that, the judge decided that the Note Trustee was not entitled to adopt the past and future AHG expenses "en bloc", on the basis that this would effectively surrender the trustee's duty to form an independent view as to whether the costs were properly incurred. He also noted a continuing lack of transparency as to what the costs related to, and a doubt as to the extent to which the Note Trustee could pay for advice on which it expressly could not rely. He added that "it is evident that the adoption of the expenses in such circumstances required a degree of careful scrutiny by the Note Trustee in order to form the opinion that the expenses were properly incurred".

The judge's conclusion on this point is not surprising, and the Note Trustee itself had conceded the point at trial. However, the judge was clearly not keen for unnecessary expense to be incurred in the Note Trustee and the AHG duplicating advice.

The practical difficulties facing the Note Trustee following this judgment (largely in assessing a significant amount of costs in order to determine whether they were properly incurred for these purposes) argue in favour of finding a different way of dealing with similar situations, which avoids the trustee becoming too enmeshed in the partisan interests of noteholders. There seems no reason why trustees and noteholders should not liaise on what advice needs to be obtained and from whom, and this case illustrates the risks of not doing so.

Dentons is the world's first polycentric global law firm. A top 20 firm on the Acritas 2015 Global Elite Brand Index, the Firm is committed to challenging the status quo in delivering consistent and uncompromising quality and value in new and inventive ways. Driven to provide clients a competitive edge, and connected to the communities where its clients want to do business, Dentons knows that understanding local cultures is crucial to successfully completing a deal, resolving a dispute or solving a business challenge. Now the world's largest law firm, Dentons' global team builds agile, tailored solutions to meet the local, national and global needs of private and public clients of any size in more than 125 locations serving 50-plus countries. www.dentons.com.

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