UK: Disposal Of Collateral By A Security Trustee

Last Updated: 11 November 2008
Article by Edward Davis and Sue Millar

In Bank of New York v Montana Board of Investments [2008] EWHC 1594 (Ch), the Court found, in relation to the disposal of assets following the default of a structured investment vehicle, that a security trustee was required to exercise prudence in the way in which it dealt with such assets and that the senior class of noteholders did not have the right to direct the trustee as to the time, manner and place of disposal of those assets.

Orion Finance Corporation ("Orion") was a structured investment vehicle whose assets consisted of residential mortgage asset-backed securities. It funded its investment in these assets by issuing various classes of debt securities, including senior notes, senior subordinated notes and capital subordinated notes. Orion's senior and subordinate note obligations were accelerated as a result of the downgrading of certain securities held by Orion, which in turn resulted in control of Orion's assets vesting in Bank of New York, which was acting as security trustee (the "Trustee").

The senior noteholders had directed that a disposal of assets should occur "as soon as reasonably practicable", not least because the proceeds of the disposal would, at their current market value, have been sufficient to pay the senior notes in full. However, the proceeds would not have been sufficient to pay the subordinate noteholders. The subordinated noteholders directed the Trustee not to liquidate any collateral, hoping that its value would rise in due course. Accordingly, the Trustee applied to Court for directions. The first defendant, a holder of senior notes, was a representative defendant on behalf of the holders of all the senior notes. The second and third defendants represented the subordinated creditors.

The Court was asked to consider the following questions:

1 Whether the security agreements gave the senior noteholders the right to direct the Trustee with respect to the time, date and manner of disposal of Orion's assets;

2 Whether, if such a right existed, such a direction by the senior noteholders, accompanied by a reasonable indemnity was:

(a) a mandatory contractual obligation; or

(b) subject to a discretion; and

3 Whether the security agreements mandated any specific timing for the disposal of the assets following default in circumstances where not all of the noteholders' interests could be redeemed.

The security agreements considered by the Court were subject to New York law, but the case was heard in the Chancery Division of the High Court because it was an urgent matter and it was perceived by the parties that the English Courts would move faster than their New York counterparts.

The Court found, on the facts, that the security agreements gave the Trustee "exclusive" discretion as to when to dispose of the assets of Orion. The relevant provisions of the security agreement provided that the Trustee "shall have the exclusive right to exercise any and all rights with respect to the Collateral and, in connection therewith, may elect to preserve all or any part of the Collateral and/or collect and convert into cash all or any part of the Collateral". The agreement also provided that if the Trustee collected the Collateral and converted it into cash it "shall sell, assign and deliver the whole or any part of the Collateral at such place or places as the Security Trustee deems best, and for cash, at public or private sale, without demand of performance or notice of intention to effect any such disposition or of the time or place thereof (except such notice as is required by law and cannot be waived)".

Accordingly, while the senior noteholders were entitled to direct the Trustee to enforce the security arrangements in relation to the assets, they did not have the right to give more detailed directions. The collateral was held for the benefit of all the secured parties, and so one particular class did not have the right to dictate the time, place or manner of a sale, and in particular to direct the Trustee to make an immediate disposal.

The Court also found that the Trustee could exercise its discretion to wait to sell the assets, provided that, in doing so, it acted in accordance with the security documents, which provided for any sale to be conducted in a "commercially reasonable manner". The Judge made it clear however, that the Trustee did not have an unfettered discretion in this regard. The documentation required that the security should be enforced promptly in order to ensure the prompt payment of the notes and this should be done in a way that was consistent with the subordination of rights set out in the documents. It was clear that a disposal could not be put off indefinitely, but a delay to see, for example, whether market conditions improved, might well be a legitimate exercise of the Trustee's discretion.

Practical implications

Although it turned on the provisions of the security arrangements, which were themselves governed by New York law, the decision gives an indication of how the English Courts will interpret security documents which set out the scope of a trustee's discretion, and is a good example of the Court taking a common sense approach to these matters.

This article was originally written for Stephenson Harwood's quarterly publication, Finance Litigation Legal Eye. If you would like to receive this publication, please contact Stephenson Harwood.

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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