England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
COMPANIES COURT

		Royal Courts of Justice Strand, London, WC2A 2LL
		19/02/2010

Mr Justice Blair :

1. Kaupthing Singer & Friedlander Ltd ("KSF") is a bank, being the English incorporated subsidiary of an Icelandic bank. It was authorised to carry on deposit-taking and other regulated activities under the Financial Services and Markets Act 2000. On 8 October 2008, it was placed into administration by order of Floyd J on the application of the Financial Services Authority. This application is made by the Joint Administrators seeking directions from the court pursuant to the Insolvency Act 1986, Schedule B1, paragraph 63, as to how they should treat a claim submitted in the administration by the Prudential Trustee Company Ltd ("the Trustee"). The claim was submitted on behalf of the holders of £50,000,000, 7.5% subordinated bonds due 2019 which were constituted by a Trust Deed dated 13 November 2003 entered into between KSF (as Issuer) and the Trustee ("the Bonds"). The Bonds were listed on the Luxembourg Stock Exchange and were publicly traded until the listing was suspended on 5 December 2008. The question is whether, on the proper construction of the relevant provisions of the Trust Deed, there is a "winding up" of KSF such that the Bonds are now subordinated to the claims of other creditors of KSF. The Trustee was served with the application but indicated that it did not intend to attend the hearing.
2. The legal background is as follows. The Enterprise Act 2002 created what Mr Tom Smith, counsel for the Joint Administrators, described as a "two-stage process" for administration. As he put it in his submissions (to which I am indebted), the "first stage" involves the performance by the administrator of his functions with the objectives of rescue, achieving a better result than liquidation and/or making a distribution to secured or preferential creditors. The "second stage" arises where the Court gives permission under paragraph 65(3) of Schedule B1 of the Insolvency Act 1986 to make a distribution to creditors who are neither secured nor preferential, i.e. unsecured creditors. (Schedule B1 was substituted by the 2002 Act for the existing provisions as to administration in the IA 1986.) This involves the administrator receiving proofs of debt, adjudicating such proofs and making a distribution to creditors in much the same way as in a liquidation. In order to facilitate the change, a new Chapter 10 to Part 2 of the Insolvency Rules 1986 was introduced to provide machinery for making distributions, modelled on the equivalent rules applicable to liquidations. Rules 2.72 to 2.105 are in essentially the same terms as the equivalent rules which apply to a liquidation.
3. These provisions came to be invoked in the case of KSF as follows. On 24 April 2009, on the application of the Joint Administrators, Henderson J made an order under paragraph 65(3), Schedule B1, IA 1986 authorising the Joint Administrators to make payments by way of interim and final distributions to creditors of KSF who are neither secured nor preferential. In the London Gazette and The Times of 20 May 2009, the Joint Administrators gave notice of their intention of declaring a first interim dividend to preferential and unsecured creditors, who were required to submit their proofs of debts by 18 June 2009. Notice of a proposed distribution is subject to the provisions of rule 2.95, Insolvency Rules 1986. The effect of the notice of 20 May 2009, it is said, was to engage the machinery in Chapter 10 ("Distributions to Creditors") Part 2 of the IR 1986. On 22 July 2009, a first interim dividend of 20p in the pound was paid to creditors of KSF. On 9 December 2009, a second interim dividend of 10p in the pound was paid. In the most recent progress report for the administration of KSF dated 30 October 2009, it was estimated that unsecured creditors of KSF would be likely to receive total dividends in the range of approximately 60p to 75p in the pound.
4. As indicated above, the Trustee submitted an insolvency claim form to the Joint Administrators claiming £50,000,000 due under the terms of the Trust Deed in respect of the Bonds. This claim form was dated 22 April 2009. It would clearly have a substantial impact on other unsecured claims if it is to be treated in the same manner. The Joint Administrators submit however, that because the Bonds are subordinated to all KSF's "Senior Liabilities", the claim should not be admitted for dividend in the administration of KSF until its Senior Liabilities have been paid in full, and then only rank for dividend against any surplus remaining after payment of the Senior Liabilities. Essentially, the contention is that what they describe as the "second stage" of an administration is functionally equivalent to a winding up, and should for the purposes of the subordination provisions in the Bonds be treated as such. Alternatively, it is said that a term should be implied to this effect. If that is wrong, then the question arises as to how the claim submitted by the Trustee should be valued. The Joint Administrators submit that the claim should be given a nil value, since, if their primary case is not accepted, it would be their intention at a convenient time to procure the conversion of KSF's administration into a compulsory or voluntary liquidation, so that the subordination can be rendered effective.

The Terms and Conditions of the Bonds

5. Condition (2) of the Terms and Conditions of the Bonds ("Status and Subordination") provides in Condition (2)(a) as follows:

"(a) The Bonds and Coupons shall constitute direct, unsecured and subordinated obligations of the Issuer and the rights of the Bondholders against the Issuer rank pari passu without any preference among themselves. The rights and claims of the Bondholders will, in the event of the winding up of the Issuer, be subordinated in right of payment in the manner provided in the Trust Deed to all Senior Liabilities (as defined in Condition 16) of the Issuer. Accordingly, payment of any amount (whether principal, premium (if any), interest or otherwise) in respect of the Bonds in such winding up is conditional upon, at the time of payment by the Issuer and immediately thereafter, the Issuer being solvent and, accordingly, no such amount which would otherwise fall due for payment shall be payable except to the extent that the Issuer could make such payment and still be solvent immediately thereafter."

6. For ease of identification, I have underlined the most important words for present purposes, though as always they have to be read in context. The issue raised by the present application is as to the meaning of "winding up" in Condition 2(a). Does it mean "winding up" only in sense of a voluntary or compulsory liquidation? Or (as the Joint Administrators submit) does it also extend to an administration where a notice of intention to distribute to creditors has been given? The notice (in this case the notice of 20 May 2009) is identified as the relevant event for these purposes, since the order made by the court under paragraph 65(3), Schedule B1, IA 1986 was in permissory terms.
7. Under Condition 4(a), KSF's basic obligation as Issuer was to redeem the Bonds on 13 November 2019 at their principal amount, interest being payable in the meantime. Condition 6 deals with "Events of Default and Enforcement". This is a potentially significant provision, because one such event is the "Insolvency of the Issuer", and this is defined in terms of a "winding up" of the company. Mr Smith accepts that the interpretation for which he contends as regards Condition 2(a) must apply equally in this context. Conditions (6)(a) and (b) provide that:

"(a) If an effective resolution is passed, or an order of a court of competent jurisdiction is made, for the Insolvency of the Issuer (otherwise than for the purposes of a consolidation, amalgamation, merger or reconstruction the terms of which have previously been approved in writing by an Extraordinary Resolution of the Bondholders) (an "Insolvency Event"), the Trustee may, subject as set out in paragraph (d) below, give written notice to the Issuer that the Bonds are, and they shall thereby forthwith become, subject to Condition 2, immediately due and repayable at their principal amount together with accrued interest as provided in the Trust Deed.

(b) If a default is made for a period of seven days or more in the payment of any principal or premium (if any) due in respect of the Bonds or for a period of 14 days or more in the payment of any interest due in respect of the Bonds (an "Event of Default"), the Trustee may, subject as set out in paragraph (d) below, institute proceedings for the Insolvency of the Issuer after giving seven London business days' prior written notice to the FSA of its intention to do so."

8. Condition 16 is the definitions provision of the instrument, of which a number of definitions are relevant. These are:

"Liabilities" means in respect of any person, all present and future sums, liabilities and obligations payable or owing by it in respect of indebtedness (whether actual or contingent, jointly or severally, or otherwise howsoever)

"Senior Liabilities" means all Liabilities except Subordinated Liabilities and Excluded Liabilities

"Subordinated Liabilities" means the Bonds and all other Liabilities of the Issuer in respect of indebtedness which is both unsecured and subordinated by its terms in right of payment to any other Liabilities in any Insolvency of the Issuer

"Insolvency" means the winding-up (in England but not elsewhere) of the relevant company

9. For completeness, there are other relevant definitions as follows:

"Excluded liabilities" means Junior Subordinated Debt and any other Liabilities which are expressed to rank or, in the opinion of the Insolvency Officer of the Issuer, would or do rank junior to the claims of Bondholders in respect of the Bonds in the Insolvency of the Issuer

"Junior Subordinated Debt" means all Indebtedness of the Issuer the terms of which provide that the obligations there under are subordinated in right of payment to all Senior Liabilities and holders of the Bonds

"Indebtedness" means (i) moneys borrowed and (ii) any notes, bonds, debentures, debenture stocks, loan stock or other securities offered, issued or distributed whether by way of public offer, private placing, acquisition consideration or otherwise and whether issued for cash or in whole or in part for a consideration other than cash.

10. The effect of these provisions is that if KSF was subject to a "winding up", this would be an Event of Default under the Bonds following which the Trustee could give notice that the Bonds were immediately due and payable. Further, if there was default in making payment of any principal or premium or interest due under the Bonds for the requisite period of time, the Trustee could thereafter commence proceedings for the winding up of KSF. (The current position is that KSF failed to pay interest due on the Bonds on 13 November 2008, 13 May 2009 and 13 November 2009.) But, in either case, upon the "winding up" of KSF, the rights and claims of the Bondholders would be subordinated to the payment of all Senior Liabilities, which as the above makes clear, are essentially defined to mean all liabilities of the Issuer (except those expressed to rank junior to the claims of Bondholders in respect of the Bonds). Subordination provisions of this kind are recognised as being effective under English law upon the insolvency of the debtor: see e.g. Re British and Commonwealth Holdings plc (No. 3) [1992] 1 WLR 672; Re Maxwell Communications Corpn plc (No. 2) [1993] 1 WLR 1402; Re SSSL Realisations (2002) Ltd [2006] Ch 610, C.A.

The treatment of the Bonds as Tier 2 capital

11. It is because such subordination provisions are effective in an insolvency that subordinated debt can qualify for inclusion in the capital of the issuing bank for regulatory purposes. In the present case, the Offering Circular noted that the net proceeds of the issue would be used by the Issuer to strengthen the regulatory capital base of the Group. This was similarly noted in the Group's statement to the market on 16 October 2003 announcing the bond issue, it being further stated that the bonds would be subordinated to the senior liabilities of the issuer. As Mr Brazzill explains in his 7^th Witness Statement, there was a substantial change in the rules as to capital adequacy from 2007 to give effect to the Basel II Accord. The following provisions in force at the time of the bond issue have been identified as being relevant to what was eligible for inclusion at that time.
12. Under Article 34(8) of the Banking Consolidation Directive (Directive 2000/12/EC of 20 March 2000 relating to the taking up and pursuit of the business of credit institutions), along with paid up share capital, reserves etc., subordinated loan capital can be included in a credit institution's regulatory capital (in the terminology of the Directive, its "own funds"). However, under Article 36(3), it is a requirement for including such capital that:

" … binding agreements exist under which, in the event of the bankruptcy or liquidation of the credit institution, they rank after the claims of all other creditors and are not to be repaid until all other debts outstanding at the time have been settled".

Neither "bankruptcy" nor "liquidation" is defined in the Directive, but the intent is clear. In the event of the institution's liquidation, the agreements constituting the loan capital have to ensure that it ranks after the claims of all other creditors, and that it is not to be repaid until all other debts have been settled. Unless this is achieved, it cannot be included within the bank's own funds. There are certain other requirements, including that the loans have an original maturity of at least five years (Article 36(4)).

13. So far as the regulatory regime in this country was concerned, these requirements were implemented in the provisions of the FSA's Interim Prudential Sourcebook for Banks (known as the "IPRU (Banks) Sourcebook") which is part of the FSA Handbook. Without going into the technicalities, the FSA distinguishes between Tier 1 capital (including share capital and reserves) and Tier 2 capital (including subordinated term debt). Section 8 of the IPRU (Banks) Sourcebook deals (or at the material time dealt) with the conditions which subordinated debt had to satisfy to be eligible as Tier 2 capital. As in force at the time of issue of the bonds in November 2003, section 8.2(b) provided:

"(b) Subordination: The terms of any agreement governing the raising of subordinated loan capital should ensure that the claims of the lender are fully subordinated to those of the unsubordinated creditors.

The FSA is more concerned that the subordination provisions should be effective than that they should follow a particular form. Subordination provisions should ensure the following:

(i) The claims of the subordinated creditors rank behind those of all unsubordinated creditors.

a) In the event of the liquidation of the bank, subordinated creditors should not be able to receive and retain any amounts until all unsubordinated creditors have been paid, or provided for, in full."

14. The Rulebook uses the term used in the Directive, namely "liquidation", rather than "winding up". Again, the intent is clear. Whatever the form of the subordination provisions, they must be effective in a liquidation to preclude repayment until all unsubordinated creditors have been paid in full. Under these provisions, the institution has to obtain a legal opinion that the subordination requirements have been met and provide the FSA with the opinion. KSF obtained an opinion to this effect from Slaughter & May dated 13 November 2003. The Bonds were duly included in KSF's capital adequacy returns from 31 December 2003 to 31 March 2008 as forming part of KSF's Tier 2 Capital. For reasons connected with rights of redemption within the minimum five year term, they were excluded thereafter, but that does not affect any of the matters under discussion.

Insolvency Act 1986

15. I have set out the legal background in paragraph 2 above. The administration procedure was first introduced into English law by the IA 1986, but no provision was included to enable an administrator to make distributions to the creditors of the company. This was inconvenient, and led to unnecessary expense caused by the need to put the company into liquidation or made subject to a voluntary arrangement (Fletcher, Higham and Trower, Corporate Administrations and Rescue Procedures, Tottel Publishing, para 15.5). Under the reforms effected by the Enterprise Act 2002 to which I have referred, the position was totally remodelled (Fletcher, The Law of Insolvency, 4^th edn (London, Sweet & Maxwell, 2009) para 16-138). With effect from 15 September 2003, Schedule B1, paragraph 65, IA 1986 ("Distribution"), provides as follows:

(1) The administrator of a company may make a distribution to a creditor of the company.

(2) Section 175 [preferential debts] shall apply in relation to a distribution under this paragraph as it applies in relation to a winding up.

(3) A payment may not be made by way of distribution under this paragraph to a creditor of the company who is neither secured nor preferential unless the court gives permission.

16. It was because of the limitation expressed in paragraph 65(3) that the application was made to Henderson J that resulted in the order of 24 April 2009 that I have mentioned. Speaking of the position generally, and without reference to the present context, it has been said that:

"The most obvious instance in which the court's permission will be sought will be in circumstances where the administrator proposes to make a distribution to unsecured creditors following a realisation of the company's assets by using administration as a surrogate mechanism for the distribution rules applicable in liquidation, thereby rendering entry into liquidation unnecessary. There are obvious costs benefits to avoiding entry into liquidation by these means, and this is a welcome contrast to the traditional position under the old law" (Lightman and Moss, The Law of Administrators and Receivers of Companies, (Sweet & Maxwell, London, 2007) para 15-011).

17. Consistent with the "second stage" of an administration, Mr Smith points out that paragraph 84, Schedule B1, IA 1986 Act provides that a company may move directly from administration to dissolution. In other words, it is now possible for a company to go into administration, to have its assets realised and distributed to creditors and then to be dissolved without going into liquidation. I am told that as a result of these changes, a number of insolvencies where distributions to unsecured creditors would previously have been made by way of a liquidation are proceeding without the company going into liquidation. Instead, distributions are being made to unsecured creditors through the enabling provisions of Schedule B1, paragraph 65, IA 1986, and the machinery in Part 2, Chapter 10, IR 1986 (which as I have said, are modelled on the equivalent rules applicable to liquidations). Examples of this in the banking field are Lehman Brothers International (Europe), as well as the present case.

Discussion and conclusions

18. The Joint Administrators submit that, properly construed, the term "winding-up" in Condition (2)(a) of the Terms and Conditions of the Bonds extends not only to compulsory or voluntary liquidation but also to administration where a notice of a proposed distribution to creditors has been given in accordance with rule 2.95 of the IR 1986 (and thus where the "second stage" of the administration process has been engaged). Alternatively, they submit that a term to such effect should be implied into Condition 2(a) and the definition of "Insolvency" which is also defined by reference to "winding-up".
19. I should begin with the contrary argument as put before the court by the Joint Administrators. It is accepted that the term "winding up" has a settled and specific meaning under the IA 1986. The "winding up" of a company is a legal term of art (or close to it). This is evident, inter alia, from the use of the term throughout the IA 1986. Where a legal term of art is used in a document, the court will normally give the term its technical meaning in law. The technical meaning in law of "winding up" of a company is its voluntary or compulsory liquidation under the provisions of the IA 1986 (see e.g. s. 73). It may be argued that effect should be given to the literal words of the Bonds and the technical meaning of "winding up". The Trust Deed dated 13 November 2003, including the terms and conditions of the Bonds, would have been carefully drafted, and those responsible aware of the provisions of the Enterprise Act 2002 (which became effective on 15 September 2003) enabling a distribution to creditors by administrators in the same manner as in a winding up.
20. I have been referred to some of the well known authorities on the construction of contractual terms. In Sirius International Insurance Co v FAI General Insurance Ltd [2004] 1 WLR 3251 Lord Steyn said at paragraph 19:

"There has been a shift from literal methods of interpretation towards a more commercial approach. In Antaios Compania Naviera SA v Salen Rederierna AB [1985] AC 191, 201, Lord Diplock, in an opinion concurred in by his fellow Law Lords, observed: 'if detailed semantic and syntactical analysis of a word in a commercial contract is going to lead to a conclusion that flouts business common sense, it must be made to yield to business common sense.' In Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] AC 749, 771, I explained the rationale of this approach as follows:

'In determining the meaning of the language of a commercial contract … the law … generally favours a commercially sensible construction. The reason for this approach is that a commercial construction is more likely to give effect to the intention of the parties. Words are therefore interpreted in the way in which a reasonable commercial person would construe them. And the standard of the reasonable commercial person is hostile to technical interpretations and undue emphasis on niceties of language.'

The tendency should therefore generally speaking be against literalism."

21. Further, the court is not bound to give a legal term of art its technical meaning, the Joint Administrators submit, citing Lewison, The Interpretation of Contracts, at 5.08, where it is stated that, "Where a document contains a legal term of art the court should give it its technical meaning in law, unless there is something in the context to displace the presumption that it was intended to carry its technical meaning".
22. It is important, in my judgment, not to take these passages beyond their proper limits. These Bonds had a maturity of 2019, were listed on the Luxembourg Stock Exchange, and were publicly traded until the listing was suspended on the collapse of KSF. Bondholders and prospective bondholders, as well as the Trustee and the Issuer, had to be able to ascertain the legal incidents of the instruments with reasonable certainty. Construction is an objective exercise which seeks to give effect to the intention of the parties. It is not for the court to substitute its own view as to what is commercially sensible, as indeed the authority I have cited makes plain. With that in mind, I can express my conclusions as follows.
23. The first, and in my view, the most important point is that the Bonds were expressed to be "subordinated". The Joint Administrators submit, in my view correctly, that the context shows that the intention was that the Bonds were to form part of the capital of KSF. In other words, in the event that KSF had insufficient assets to pay its creditors, then the Bonds were to rank in priority for payment behind the claims of other creditors of KSF. This intention is apparent from the repeated description of the Bonds as "subordinated", a term incorporated in the title of the issue, as well as from the subordination provisions. The terms of the Offering Circular state that the Bonds are to be subordinated to the Senior Liabilities, and that the proceeds of the issue are to be used by the Issuer to strengthen the bank's regulatory capital base. KSF's public statement to the market on 16 October 2003 announcing the bond issue is to the same effect. It was essential, if the purpose was not to be rendered futile, that the subordination satisfied the FSA requirement that, in the event of the liquidation of the bank, the Bondholders should not be able to receive any amounts until all the unsubordinated creditors had been paid in full.
24. In the event, KSF does not have sufficient assets to pay its creditors. The Joint Administrators submit that the distribution which they incepted by the application which led to the order of 24 April 2009 under paragraph 65(3), Schedule B1, IA 1986 authorising them to make payments by way of interim and final distributions to creditors of KSF who are neither secured nor preferential, is in substance equivalent to a distribution made by a liquidator in the course of a winding up. I agree with this submission. As it is put by Professor Sir Roy Goode QC, "… in making distributions to creditors the administrator is performing a function similar to that of a liquidator …" (Goode, Principles of Corporate Insolvency Law, para 10-81). It must, in my judgment, have been the intention of the parties that in such a process, the claims of the Bondholders would be subordinated in the same manner as would have been the case in the winding up of a company by way of voluntary or compulsory liquidation. The absence of an express reference to the paragraph 65(3) process may be explained by the fact that when this Trust Deed was drafted, the provisions of the Enterprise Act 2002 had only just come into force. Alternatively, it may have been considered that the words "winding up" were wide enough to cover the paragraph 65(3) process. I am not concerned with the subjective views of the contracting parties or their lawyers at the time. In my judgment, the Joint Administrators are correct to submit that, objectively construed, the term "winding-up" in Condition (2)(a) of the Terms and Conditions of the Bonds scheduled to the Trust Deed dated 13 November 2003 extends not only to compulsory or voluntary liquidation, but also to administration where a notice of a proposed distribution to creditors has been given in accordance with rule 2.95 of the IR 1986. It would in my view be pointless to require the company to be put into liquidation to achieve that result. On that basis, I need not deal with the submissions that have been made as regards implied terms, or valuation. I shall make a declaration that gives effect to this outcome so far as the Trustee's claim of 22 April 2009 is concerned.