England and Wales High Court (Commercial Court) Decisions

IN THE HIGH COURT OF JUSTICE
QUEEN'S BENCH DIVISION
COMMERCIAL COURT

		Royal Courts of Justice Strand, London, WC2A 2LL
		05/11/2012

Mr Justice Cooke:

Introduction

1. The parties to this action are in dispute as to the proper construction of documentation which governs a 2006 issuance of "commercial mortgage-backed securities" (a CMBS) in a securitisation of commercial properties. An expedited trial was ordered because of the need for certainty in the current administration of the transaction.
2. The First Claimant, GEMINI (ECLIPSE 2006-3) PLC (the Issuer), is an English public limited liability company which, as part of the securitisation transaction (the Securitisation), in November 2006 issued £918,862,000 commercial mortgage-backed floating rate notes due July 2019 in five separate classes (the Notes). The Issuer is a special purpose vehicle and was established for the limited purposes of the Securitisation and the issuance of the Notes.
3. The Second Claimant, The Bank of New York Mellon (formerly, The Bank of New York) acting through its London branch, is a wholly owned subsidiary of The Bank of New York Mellon Corporation incorporated under the laws of the State of New York. It is the cash manager in respect of the Securitisation (the Cash Manager).
4. The First Defendant, Danske Bank A/S, is a public limited company organised under the laws of the Kingdom of Denmark. It is the liquidity facility provider in relation to the Securitisation (the Liquidity Facility Provider - in abbreviated form the LFP).
5. The Second Defendant, BNY Mellon Corporate Trustee Services Limited (formerly, BNY Corporate Trustee Services Limited), is a private English company and the trustee appointed to represent the interests of the holders of the Notes (the Trustee). The Trustee has been joined as a defendant in these proceedings to ensure that it is bound by, and is able to take the benefit of, any determination of this application by the High Court. In a letter from its solicitors dated 25 July 2012, it indicated that it did not intend to take an active part in the proceedings and has not done so. The parties however agreed a Statement of Agreed Facts and Issues, which are, so far as relevant, recorded in this Introduction and paragraphs 6-38 of this judgment.

The Securitisation

6. As part of the Securitisation, on 14 November 2006 the Issuer issued the five classes of securities (Classes A to E) which together comprise the Notes. The Notes were constituted by a trust deed entered into between the Issuer and the Trustee dated 14 November 2006 (the Trust Deed). The Trust Deed and the Notes are governed by English law.
7. The terms and conditions of the Notes and a description of the Securitisation are set out in a Prospectus issued by the Issuer dated 10 November 2006. For the purposes of the Securitisation and the Notes, various capitalised terms are defined in a Master Definitions Schedule dated 14 November 2006 (the MDS).
8. With the proceeds of the Notes issuance the Issuer acquired a loan secured over a portfolio of commercial properties in the United Kingdom (the Loan) and related assets. The Issuer uses receipts of amounts under the Loan, together with certain other funds available to it, to make payments of interest on and repayments of principal in respect of the Notes, as well as certain other payments in connection with the Securitisation.
9. Those other funds available to the Issuer include drawings under a Liquidity Facility Agreement described under the heading "The Liquidity Facility" below.
10. Payments by the Issuer in connection with the Securitisation are subject to various Priorities of Payments under which categories of creditor of the Issuer are set out in an order of priority such that no payment is due to a particular category of creditor unless and until all creditors with a higher-ranking priority have been paid in full (referred to in argument as "the waterfall"). Pre-acceleration, different Priorities of Payment apply to: (a) funds received by the Issuer as income receipts; and (b) funds received by the Issuer as principal receipts, as further detailed in Clause 11.3 of a Cash Management Agreement dated 14 November 2006 (the Cash Management Agreement). The Priorities of Payments are set out in Schedules 1 and 2 to that agreement.

The Liquidity Facility

11. Pursuant to a liquidity facility agreement dated 14 November 2006 (the Liquidity Facility Agreement – in abbreviated form the LFA) between the LFP, the Cash Manager, the Trustee and the Issuer, the LFP provided a £64,000,000 liquidity facility to the Issuer in relation to the Securitisation (the Liquidity Facility). The Liquidity Facility Agreement is governed by English law.
12. The purpose of the Liquidity Facility is primarily to provide an immediately available source of liquid funds to provide some liquidity support for the timely payment of certain payment obligations of the Issuer in circumstances where the receivables generated by the underlying assets (the Loan) are insufficient to satisfy those payment obligations. This is achieved by the Liquidity Facility being drawn upon to:

a) make up shortfalls of interest received on the underlying Loan, such drawings being referred to as Loan Income Deficiency Drawings;

b) pay certain amounts that can be applied and/or which are due to third party unsecured creditors of the Issuer (not the Noteholders or the Liquidity Facility Provider), such drawings being referred to as Revenue Priority Amount Drawings; and

c) pay certain amounts to be paid and/or due to certain secured creditors of the Issuer, such drawings being referred to as Expenses Drawings.

In addition, the Liquidity Facility may also (subject to certain conditions) be used to fund payments of certain amounts due from the borrowers which, if not paid, may result in, for example: (a) a reduction in value of the property asset(s) on which the Loan is secured; or (b) a payment default under a hedging arrangement entered into by a borrower. Such drawings are referred to as Loan Protection Drawings.

13. On issuance, the Notes were assigned credit ratings by Fitch Ratings Ltd. (Fitch), Moody's Investors Service Limited (Moody's) and Standard & Poors Ratings Services (S&P). These ratings were assigned following discussion with each of Fitch, Moody's and S&P prior to the documentation for the Securitisation being finalised. The Liquidity Facility was structured, amongst other things, so as to enable the Notes to be assigned these ratings upon issuance.
14. Distinct from the credit rating of the Notes, the Liquidity Facility Provider itself had at all material times a general corporate credit rating from various rating agencies. On 5 February 2009, S&P downgraded that general corporate credit rating of the Liquidity Facility Provider. As a result of the downgrade, on 11 February 2009, the Cash Manager (on behalf of the Issuer) made a stand-by drawing of the entire available commitment under the Liquidity Facility of £64,000,000 (such drawdown constituting a "Liquidity Stand-by Drawing"). These funds have been credited to the Liquidity Stand-by Account held with The Bank of New York Mellon (as Account Bank in relation to the Securitisation), and any drawing under the Liquidity Facility as described in paragraph 12 above is to be made by withdrawing the relevant amount from the Liquidity Stand-by Account. The Issuer (or the Cash Manager on its behalf) can only make withdrawals from the Liquidity Stand-by Account in accordance with the restrictions set out in Clause 6.4(a) of the Liquidity Facility Agreement.
15. In November 2009, the Liquidity Facility Provider obtained a separate rating from Moody's in relation to the Liquidity Facility (a Counterparty Instrument Rating). This was obtained in order to mitigate increased costs referred to below under the heading "Liquidity Facility Increased Costs". The Counterparty Instrument Rating was distinct from the rating of the Notes (paragraph 13 above) and the general corporate rating of the Liquidity Facility Provider itself (paragraph 14 above).
16. On 8 June 2011, Moody's announced that it was reviewing the Counterparty Instrument Rating since it appeared to Moody's (contrary to an assumption which Moody's said it made when granting the Counterparty Instrument Rating in November 2009) that only interest payments made under the Loan (and not principal repayments) would be available to repay the Liquidity Facility.
17. On 14 February 2012, Moody's announced that it was withdrawing the Counterparty Instrument Rating on the basis that it had insufficient or otherwise inadequate information to support the maintenance of the rating (the Rating Withdrawal).

The Loan default; but no acceleration under the Loan or the Notes

18. The Issuer, the Cash Manager and the Liquidity Facility Provider agree that the Loan is currently in default but neither the Loan nor the Notes issued by the Issuer have been accelerated. Furthermore, the Notes have not otherwise become due and payable in full. [Since the Statement of Facts was agreed, the Loan has been declared to be in default and has been accelerated, but not the Notes. It is agreed that this factor does not affect the points at issue.]
19. The Issuer has made various Loan Income Deficiency Drawings pursuant to clause 6.1(a) of the Liquidity Facility Agreement. Such drawings have taken effect by way of a debit to the Liquidity Stand-by Account.
20. The balance standing to the credit of the Liquidity Stand-by Account according to the most recent statement provided by the Account Bank dated 25 July 2012 was £38,397,844.54.

Liquidity Facility Increased Costs

21. According to a note provided to the Issuer by the Liquidity Facility Provider on 16 March 2012 (detailed below), at the time the Liquidity Facility Agreement was entered into in November 2006, Finanstilsynet (the Danish financial regulator) applied the Basel I regime to determine the regulatory capital costs of banks incorporated in Denmark (including the Liquidity Facility Provider). According to that note, following the implementation of Basel II in Denmark by Finanstilsynet, the Liquidity Facility Provider would have incurred additional regulatory capital costs in respect of its commitment under the Liquidity Facility but such costs were mitigated (but not entirely avoided) by the Liquidity Facility Provider obtaining the Counterparty Instrument Rating referred to above.
22. On each Interest Payment Date falling between 25 January 2011 and 25 April 2012 (inclusive), six payments of Liquidity Facility Increased Costs were demanded by the Liquidity Facility Provider and were subsequently paid by the Cash Manager (on behalf of the Issuer) to the Liquidity Facility Provider. In each case, the amount of such Liquidity Facility Increased Costs was less than 0.125% per annum of the Liquidity Facility Commitment (being £64,000,000) less Liquidity Facility Increased Costs already paid in the applicable year. As such, these amounts did not constitute Liquidity Subordinated Amounts and fell to be paid under sub-paragraph (e) of the Pre-Acceleration Revenue Priority of Payments outlined in Schedule 1 to the Cash Management Agreement (the waterfall).
23. During the weeks following the Rating Withdrawal of the Counterparty Instrument Rating, the Issuer and the Liquidity Facility Provider sought to agree a series of amendments to the Securitisation documentation (which amendments were to be put to Noteholders for their consideration) to enable a re-application to be made by the Liquidity Facility Provider for a suitable rating of the Liquidity Facility.
24. As part of the process of explaining the need for such amendments to the Trustee, the Liquidity Facility Provider sent a note to the Issuer on 16 March 2012. In its note, the Liquidity Facility Provider stated that it would incur increased regulatory capital costs on its commitment under the Liquidity Facility as a result of the Rating Withdrawal. In its note, the Liquidity Facility Provider claimed that such increased regulatory capital costs were recoverable from the Issuer pursuant to clause 14 of the Liquidity Facility Agreement as Liquidity Facility Increased Costs.
25. The attempts to obtain a suitable rating through the proposed amendments did not proceed.
26. By a letter to the Issuer dated 28 May 2012 (copied to the Cash Manager), the Liquidity Facility Provider submitted an invoice for the payment to it of Liquidity Facility Increased Costs for the period from 25 April 2012 to 27 July 2012 in the amount of £1,914,739.73 (equating to 12.00% per annum of the Liquidity Facility Commitment (being £64,000,000) pro-rated for 91 days). This amount (the July Increased Costs) was stated to be due from the Issuer pursuant to clause 14 of the Liquidity Facility Agreement on the next Interest Payment Date (25 July 2012).

Non-subordinated part of the July Increased Costs

27. It is not disputed by the Issuer or the Cash Manager that the July Increased Costs constitute Liquidity Facility Increased Costs.
28. Of the July Increased Costs, £19,945.21 (being equal to 0.125% of the Liquidity Facility Commitment less Liquidity Facility Increased Costs already paid in the applicable year) was due and/or payable by the Cash Manager (on behalf of the Issuer) to the Liquidity Facility Provider on 25 July 2012. Since it did not constitute a Liquidity Subordinated Amount, this amount (the Non-Subordinated Liquidity Facility Amount) was payable out of the Adjusted Available Issuer Income under sub-paragraph (e) of the Pre-Acceleration Revenue Priority of Payments in priority to the Noteholders. This amount was duly paid on 25 July 2012.

Dispute in relation to the remainder of the July Increased Costs

29. The remainder of the July Increased Costs (being £1,894,794.52) constitutes Liquidity Subordinated Amounts (the July Liquidity Subordinated Amounts). To the extent that any Liquidity Subordinated Amounts are payable on an Interest Payment Date, they are due and/or payable under sub-paragraph (m) of the Pre-Acceleration Revenue Priority of Payments (the waterfall) and are therefore not payable in priority to Noteholders (or certain other creditors of the Issuer).
30. Following the Liquidity Facility Provider's letter of 28 May 2012, a dispute arose between the Issuer and the Cash Manager (on the one hand) and the Liquidity Facility Provider (on the other hand) as to whether the July Liquidity Subordinated Amounts were payable on 25 July 2012 and whether an Expenses Drawing should be made under the Liquidity Facility in respect of them.
31. The July Liquidity Subordinated Amounts were not paid on 25 July 2012 and no drawing under the Liquidity Facility has been made in respect of them by the Cash Manager or the Issuer, in each case in accordance with the terms of the interim agreement (described in the section entitled "Interim Agreement" below).
32. The Adjusted Available Issuer Income in relation to the 25 July 2012 Interest Payment Date (adopting the understanding of the Issuer and the Cash Manager as to the circumstances in which an Expenses Drawing is required to be made (an interpretation which is disputed by the Liquidity Facility Provider)) was insufficient to pay the interest due and owing to holders of the Class D and Class E Notes (under sub-paragraphs (k) and (l) of the Pre-Acceleration Revenue Priority of Payments, namely £333,625.60 and £431,941.50 respectively) and to pay part of the interest due and owing to holders of the Class C Notes (under sub-paragraph (j) of the Pre-Acceleration Revenue Priority of Payments, namely £343,468.21).
33. Under the Pre-Acceleration Revenue Priority of Payments, these amounts are payable in priority to any amounts payable in respect of Liquidity Subordinated Amounts.
34. On 25 July 2012, the July Liquidity Subordinated Amounts exceeded the funds required to satisfy in full the shortfall in amounts under sub-paragraphs (j), (k) and (l) of the Pre-Acceleration Revenue Priority of Payments by £785,759.22. Consequently if, contrary to the understanding of the Issuer and the Cash Manager but in accordance with the understanding of the Liquidity Facility Provider, the July Liquidity Subordinated Amounts had been payable and an Expenses Drawing had been required to be made in respect of the July Liquidity Subordinated Amounts on 25 July 2012, there would have been £785,759.22 available to apply towards the payment of the July Liquidity Subordinated Amounts.

Interim Agreement

35. In light of the then approaching 25 July 2012 Interest Payment Date, by an agreement dated 11 July 2012, the Issuer, the Cash Manager, the Liquidity Facility Provider and the Trustee agreed terms providing for the interim period that would fall prior to a final and conclusive court resolution of the matter (the Agreement). Amongst other things, the Agreement provides that the Liquidity Facility Provider will not take any action to enforce any rights or make any claim it may have in connection with any alleged or actual non-payment of the claimed Liquidity Facility Increased Costs, other than to put forward its position in the course of these proceedings. The Agreement is stated to expire if a final and conclusive court resolution does not occur before the earlier of: (i) 30 November 2012; (ii) the date on which the balance standing to the credit of the Liquidity Standby Account falls below £20,000,000; and (iii) the occurrence of a Note Event of Default.
36. The Liquidity Facility Provider will make similar claims for payment of Liquidity Facility Increased Costs in relation to subsequent Interest Payment Dates (on the same grounds as the claims for July Increased Costs) and an equivalent dispute to that relating to the July Increased Costs will arise between the parties in relation to such similar claimed Liquidity Facility Increased Costs, if this matter is not resolved. To the extent that equivalent issues arise in respect of future claims for Liquidity Facility Increased Costs validly made in accordance with the Liquidity Facility Agreement, each of the parties has agreed that it will act consistently with the approach adopted by the court in any prior final and conclusive court resolution reached pursuant to these proceedings.

Issues on which the parties are in agreement

37. The Issuer, the Cash Manager and the Liquidity Facility Provider do not dispute that:

a) the amounts claimed by the Liquidity Facility Provider in relation to the 25 July 2012 Interest Payment Date constitute Liquidity Facility Increased Costs;

b) the Non-Subordinated Liquidity Facility Amount was due and payable to the Liquidity Facility Provider on 25 July 2012 (under sub-paragraph (e) of the Pre-Acceleration Revenue Priority of Payments set out in the Cash Management Agreement) and was duly paid;

c) on the facts there was no need for the Issuer or Cash Manager to make any Expenses Drawing under the Liquidity Facility Agreement in order to fund the Non-Subordinated Liquidity Facility Amount on the 25 July 2012 Interest Payment Date;

d) the remainder of the Liquidity Facility Increased Costs (comprising £1,894,794.52 in relation to the 25 July 2012 Interest Payment Date) constitute Liquidity Subordinated Amounts; and

e) to the extent that July Liquidity Subordinated Amounts were due and/or payable on 25 July 2012, they were only payable in accordance with the Pre-Acceleration Revenue Priority of Payments under which interest owing to Noteholders is to be paid in priority to any Liquidity Subordinated Amounts (which fall at sub-paragraph (m) in the Pre-Acceleration Revenue Priority of Payments).

Issues on which the parties are not in agreement

38. The Issuer and the Cash Manager, on the one hand, and the Liquidity Facility Provider, on the other, do not agree on the following issues:

a) whether the July Liquidity Subordinated Amounts were due and/or payable on 25 July 2012; and

b) whether an Expenses Drawing was required to be made under the Liquidity Facility Agreement and the Cash Management Agreement in respect of those amounts.

Principles of Construction

39. There was unsurprisingly no real issue between the parties as to the approach to be taken, with citation by the parties of the same authorities. Reference was made to Investors Compensation Scheme Limited v West Bromwich Building Society [1998] 1 WLR 896 and particularly to pages 912-913 and to Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900 paragraphs 14 and 21-23. Other authorities were cited with regard to adopting a commercial construction and, where the language of the parties could be construed in two different ways, to adopting the construction which was most consistent with business common sense, by an iterative process involving the checking of each of the rival meanings with the other provisions of the document and investigating its commercial consequences. The aim is to ascertain what the reasonable person would have understood the parties to have meant by the words that they used, with such reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.
40. Leading Counsel for the parties each accepted that, notwithstanding the fact that no Events of Default had been declared under the Loan or Notes, the Transaction was not working in the manner envisaged by the parties. Over a period of some years, since October 2009, the payments of interest under the Loan had not been sufficient fully to meet the payments of interest due on each class of the Notes. Loan Income Deficiency Drawings totalling over £20,000,000 had been used during that time to fund the payment of interest on the Notes because of the continuing poor performance of the underlying property portfolio. Whereas the parties accepted that the concept of the Loan Income Deficiency Drawings was to cover shortfalls in interest payable on the Notes, and other priority sums, and Expenses Drawings were intended to be drawn down to pay certain amounts to be paid and/or due to certain secured creditors of the Issuer (see paragraph 12(c)), the former drawings had been inadequate for the former purpose with the result that the situation described in paragraphs 26-34 above arose. It is thus apparent that the provisions of the transaction documents which are the subject of dispute fall to be applied to circumstances which the parties may well not have contemplated when entering into the transaction.
41. Mr Richard Salter QC for the LFP described the transaction as broken and referred to a letter from the Special Servicer dated 19th March 2012, in which the effect of continued provision of loans under the Liquidity Facility was estimated, with funds intended only to be made available on a temporary basis under the LFA, entirely exhausted by January 2015 on the Issuer's construction and £60m utilised by July 2016, when the Notes matured, on the LFP's construction. Mr William Trower QC for the Issuer did not take issue with the description. In that letter the Special Servicer estimated that, on then current valuations, proceeds of sale of the properties would result in a 100% capital loss to each class of Noteholder other than Class A.
42. At paragraph 12 above, I have set out the purpose of the Liquidity Facility as agreed by the parties in the Agreed Statement of Facts and Issues. The basic object is to provide liquidity support for the timely payment of specified payment obligations of the Issuer where the receivables generated by the underlying assets of the Loan and mortgages (essentially rent from commercial properties) are insufficient to meet those liabilities. The aim is to provide temporary facilities to obviate or ameliorate cash flow difficulties to keep the transaction on foot and avoid Events of Default on the Notes or the Loan. The Issuer is, in my judgment, correct in saying that this aim must be borne in mind when construing the transaction documents and when considering the most commercial interpretation to adopt in a situation which the parties may well not have envisaged as likely, but where they have provided for subordination of obligations owed by the Issuer.
43. The Issuer pointed out that the LFP was party to the LFA and to the Issuer Deed of Charge but not to the Cash Management Agreement. But it did not seem to me that anything much turned on this. Clause 23 of the LFA refers in terms to the "funds available to be applied in accordance with the Cash Management Agreement and the Issuer Deed of Charge" so that the provisions of these documents must be read together. Furthermore, the Issuer Deed of Charge secures the Issuer Secured Obligations which are defined in the MDS as all the obligations of the Issuer owed to the Issuer Secured Creditors, which include the LFP, whilst clause 3.1 constituted the assignment of all the Issuer's rights and benefits in the Loan and the security trusts created over the related security to the Trustee, to hold for the benefit of itself and the other Issuer Secured Creditors. Additionally, clause 3.2 of the same Deed constituted an assignment by the Issuer, by way of first fixed security for payment of Issuer Secured Obligations to the Trustee of all the Issuer's rights under the Deed and various other agreements including the Cash Management Agreement.
44. Nonetheless, to my mind it is self-evident that, in order to understand the parties' respective rights, reference must first be made to the agreement (to which both the Issuer and the LFP are original parties) which governs the provision of the Liquidity Facility, namely the LFA, together with, so far as relevant the Issuer Deed of Charge and Cash Management Agreement, to which reference is made. The LFA is the primary document which set outs the terms upon which the credit facility is made available, whilst the CMA essentially sets out the Cash Manager's obligations and the Issuer Deed of Charge provides security to the Trustee in respect of the Issuer Secured Obligations and provides for payments to discharge them. The LFA is the prime instrument to which regard must be had to determine the position between the Issuer and the LFP.

The LFA

45. Clauses 2, 3 and 6 of the LFA require the LFP to provide the Liquidity Facility and for its use by the Cash Manager on behalf of the Issuer, after making a Liquidity Facility Request, for the purpose of drawing down loans of various types to make good various types of shortfall. There are Loan Income Deficiency Loans (where there is a shortfall in interest due by a Borrower under the Credit Agreement on any Loan Interest Payment Date), Revenue Priority Amount Loans (to pay expenses to third parties who are not Issuer Secured Creditors), Loan Protection Loans (to cure loans or security at risk) and Expenses Loans. This last category of loans is drawn down by Expenses Drawings, which are defined in the MDS as drawings to cover "a shortfall in funds available to the Issuer to pay amounts due from time to time to the Issuer Secured Creditors (other than the Noteholders)". By the terms of clause 3.1(d), "each Expenses Loan may be used only to make payments to the Issuer equal to any shortfall in any amounts to be paid by the Issuer on any Interest Payment Date to the Issuer Secured Creditors (other than the Noteholders)".
46. The Issuer Secured Creditors are defined in the MDS as "the Trustee (for itself and on behalf of the other Issuer Secured Creditors, any Receiver or other Appointee of the Trustee, the Noteholders, the Master Servicer … [and other Servicers] … the Liquid Facility Provider, the Cash Manager, the Basis Swap Provider, the Account Bank, the Seller, the Principal Paying Agent, the Agent Bank… [other paying Agents] and any Acceding Issuer Secured Creditor". It is important to bear in mind, in construing the provisions of the LFA in relation to Expenses Loans, that the LFP is only one potential Issued Secured Creditor amongst a number of such creditors and that, as appears hereafter, it ranks fifth in line for some expenses and thirteenth in line in respect of Liquidity Subordinated Amounts.
47. Under clause 14 "the Issuer must pay to the Liquidity Facility Provider the amount of any Liquidity Facility Increased Cost incurred by the Liquidity Facility Provider" as a result of any change in laws or regulations, such as occurred with the introduction of Basel II. It is not disputed that the LFP has incurred Liquidity Facility Increased Costs, part of which constitute Liquidity Subordinated Amounts. The obligation to pay is, as the LFP points out, mandatory in its terms.
48. Liquidity Subordinated Amounts are defined in the MDS as "any amounts in respect of increased costs…and payable to the Liquidity Facility Provider to the extent that such amounts exceed 0.125% per annum of the commitment provided under the Liquidity Facility Agreement". Thus the first 0.125% per annum of such costs do not fall into the category of Liquidity Subordinated Amounts and no issue arises between the parties in relation to it. That amount has been paid under clause 14, whereas the balance demanded, which it is agreed does constitute Liquidity Subordinated Amounts. is disputed, as set out in paragraphs 27-34 above.
49. The Issuer submits that the primary question which arises is whether there was any amount "due to the Issuer Secured Creditors (other than the Noteholders)", meaning here the LFP, on 25 July 2012, in respect of that part of the Liquidity Facility Increased Costs which represent Liquidity Subordinated Amounts. The Issuer's submission is that clause 23 has the effect that no such sums are due.
50. Clause 23 is the clause which sets out the subordination of various items, with its two sub-clauses, which read as follows:

(23)(a) "The Liquidity Facility Provider acknowledges to the Issuer and the Trustee that it is bound by the terms of the Issuer Deed of Charge and agrees that, notwithstanding any other provision of this Agreement, the Liquidity Subordinated Amounts and all other amounts due to it in accordance with the terms of this Agreement will only be due and payable if and to the extent that the Issuer has funds available to be applied in accordance with the Cash Management Agreement and the Issuer Deed of Charge in or towards payment of the Liquidity Subordinated Amounts and all other amounts due to it in accordance with the terms of this Agreement after all amounts required to be paid in priority thereto under the Cash Management Agreement and the Issuer Deed of Charge have been discharged or paid in full." 

(23)(b) "Interest shall accrue on the amount of any Liquidity Subordinated Amounts otherwise due and payable but which are not due and payable as a result of the provisions of this Clause 23 (Subordination) at the rate referred to in Clause 9.l(a)(i). Any Liquidity Subordinated Amounts otherwise due and payable but which are not due and payable as a result of this Clause 23 (Subordination), together with accrued interest thereon, shall be treated as Liquidity Subordinated Amounts due and payable, subject to the provisions of this Clause 23 (Subordination), on the next following Interest Payment Date."

51. In my judgment, as the Issuer submits, this clause is of fundamental importance in the context of the dispute. First, in accordance with its terms, clause 23(a) is expressly to prevail over any other provision of the LFA ("notwithstanding any other provision of this Agreement"). Secondly, it provides for a contingent debt subordination, inasmuch as it states that a Liquidity Subordinated Amount is only due and payable to the LFP to the extent that the Issuer has enough funds in hand to pay after it has paid all amounts payable in priority to it under the provisions of the CMA and the Issuer Deed of Charge. Thus, unless there are such funds available under the CMA after payment of the priority obligations, no sum is due and payable at all to the LFP. The words "if and to the extent that" make it clear that no obligation to pay arises unless that contingency is satisfied and payment is only due to the extent that there is money in hand beyond the earlier priorities to pay the LFP.
52. It is right to note that it is not just Liquidity Subordinated Amounts which are caught by this clause. It also catches "all other amounts due to" the LFP in accordance with the LFA. This would include the repayment of Liquidity Loans, including Expenses Loans (clause 7.1), interest on such loans (clause 9), fees for the Liquidity Facility Commitment (clause 35) and various expenses covered by clause 27.1(a). These amounts, together with the first 0.125% of the Increased Facility Costs, would fall into a higher ranking priority category than the Liquidity Subordinated Amounts (category (e) as opposed to (m) of Schedule 1 to the CMA). Thus the effect of the Issuer's construction is that none of these amounts, though constituting debts of the Issuer, become due and payable unless and until, and only to the extent that, there is cash available to pay them after payment of higher priority obligations, without making any Expenses Drawing.
53. Clause 23(b) then provides for what is to happen in the event that there are insufficient funds to pay the Liquidity Subordinated Amount in question (but makes no reference to the "other amounts" caught by the clause.) Interest will accrue on the unpaid Liquidity Subordinated Amounts, which, it is repeated, are "not due and payable". Such amounts "which are otherwise due and payable but which are not due and payable as a result of this Clause 23 (Subordination)", with the added interest, will be treated as Liquidity Subordinated Amounts due and payable on the next Interest Payment Date, but once again "subject to the provisions of this Clause 23", so that, if there are again insufficient funds to pay all the priority obligations, the same process will be repeated and the payment rolled over, with interest attracted, until the following Interest Payment Date.
54. It is beyond argument that the provisions of clause 14, which require payment of Liquidity Facility Increased Costs, are subject to the terms of clause 23 by which the LFP acknowledges that, "notwithstanding any other provision of this Agreement", sums payable in respect thereof are only due and payable if the priority payments can and have been made.
55. Clause 23 is reinforced by the terms of clause 22 of the LFA, which sets out the Liquidity Facility Events of Default. Subclause (a) makes non-payment by the Issuer of any amount payable under the LFA "on the due date" such an event, if it remains unremedied for 3 business days. Sub-clause (b) however provides that non-payment of any Liquidity Subordinated Amount is only an Event of Default "if the Issuer has the requisite funds to pay such amount in accordance with the provisions of the CMA and the Issuer Deed of Charge" and fails to pay within 3 business days of "the relevant due date". Thus there could only be an event of default if the Issuer has the funds in hand to which clause 23 refers and ""the relevant due date" has arrived."
56. The LFP contends however that "the funds available to be applied in accordance with the Cash Management Agreement and the Issuer Deed of Charge" (the phrase which appears in clause 23(a)) are constituted by the Adjusted Available Issuer Income, which includes Expenses Drawings, so that the contingent subordination is only effective after Expenses Loans have been drawn down, so that the total available funds are swollen by the drawdown.
57. It is clause 6 of the LFA which provides for utilisation of the facility and sub-clause 1(d) which sets out the basis for making an Expenses Drawing. That sub-clause provides:

"If on any Calculation Date the Cash Manager determines that there is a shortfall in any amounts to be paid by the Issuer pursuant to the terms of the Transaction Documents to the Issuer Secured Creditors (other than the Noteholders), the Cash Manager must prior to a Liquidity Facility Event of Default (and following receipt of notice that any steps have been taken by the Trustee to enforce the Issuer Security, subject to the directions of the Trustee (or any Receiver)) on behalf of the Issuer make an Expenses Drawing on the next following Interest Payment Date in an amount equal to the relevant shortfall by giving to the Liquidity Facility Provider a duly completed Liquidity Facility Request for an Expenses Loan. "

58. The determination of the relevant shortfall is to be carried out by the Cash Manager on a Calculation Date (3 London business days before an Interest Payment Date) with a view to making an Expenses Drawing on the next Interest Payment Date. The relevant shortfall, under the sub-clause, is in "any amounts to be paid by the Issuer, pursuant to the terms of the Transaction Documents, to the Issuer Secured Creditors (other than the Noteholders)", where such Issuer Secured Creditors include (inter alios) the Trustee, the Servicers of the Loan, the LFP, the Cash Manager and various Paying Agents. The focus is on "amounts to be paid" under the Transaction Documents, which include the LFA, the CMA and the Issuer Deed of Charge.
59. It is therefore necessary to examine the CMA and the Issuer Deed of Charge to which this sub-clause refers and to which clause 23 of the LFA makes express reference in order to see what amounts fall to be paid and how that might impact on the terms of clause 23(a) of the LFA.

The CMA

60. Under the CMA the Cash Manager is appointed by the Issuer and the Trustee to perform the services set out in the CMA on their behalf. The Cash Manager undertakes to perform cash management services and operate the Issuer Accounts and act according to the CMA. The Cash Manager:

a) under clause 6.1 has to maintain a Revenue Ledger in respect of revenue amounts received and paid by the Issuer and a Liquidity Ledger in respect of drawings under the LFA.

b) under clause 6.2 has to:

i) credit the Revenue Ledger with "all Available Issuer Income….. Expenses Drawings [and other Drawings] transferred and credited to the Transaction Account….. and debit the Revenue Ledger with all payments made by or on behalf of the Issuer out of Available Issuer Income, Adjusted Available Issuer Income" or other amounts available.

ii) credit the Liquidity Ledger with any amounts paid to the LFP on an Interest Payment Date and debit the Liquidity Ledger with all drawings under the LFA.

61. "Available Issuer Income" is unremarkably defined in the MDS as all monies to be paid to the Issuer in respect of the Loan, interest earned on sums in hand and on investments, but "Adjusted Available Issuer Income" is defined as Available Issuer Income plus various types of Liquidity Drawings, including Expenses Drawings.
62. On each Calculation Date, under clause 7, the Cash Manager has to calculate (inter alia) the Adjusted Available Issuer Income and the Available Issuer Income and "amounts payable…under the Pre-Acceleration Revenue Priority of Payments" which are defined in the MDS by reference to Schedule 1 to the CMA.
63. That Schedule includes the following opening paragraph:

"Prior to the delivery of an Acceleration Notice or the Notes otherwise becoming due and repayable in full and the Trustee taking any steps to enforce the Issuer Security, the Cash Manager (on behalf of the Issuer) will, on each Interest Payment Date, apply Adjusted Available Issuer Income credited to the Revenue Ledger in the following order of priority (in each case only if and to the extent that the payments and provisions of a higher priority have been made in full):"

64. It goes on to set out various expenses of the Trustee, the Paying Agents, the Master Servicer, the Cash Manager, the Corporate Services Provider and expenses of certain third parties at items (a) to (d) before at (e) providing for payment of amounts due and payable by the Issuer to the LFP under the LFA on Interest Payment Dates (other than Liquidity Subordinated Amounts). This therefore covers the previously mentioned portion of the Liquidity Facility Increased Costs equal to 0.125% pa of the LFA commitment and the other payment obligations to which I have referred at paragraph 52 above. Various further expenses follow in the waterfall Schedule including payments of interest under the 5 different classes of Notes (A-E) and below these expenses is item (m) which constitutes payment of any Liquidity Subordinated Amounts payable on an Interest Payment Date to the LFP.
65. It is clause 11 which governs distributions from the Transaction Account where clause 11.3(a) provides for payment of Pre-Acceleration Revenue Priority of Payments by reference to that Schedule. The Cash Manager is to:

"on each Interest Payment Date, transfer or procure the transfer and application of the Adjusted Available Issuer Income amount standing to the credit of the Transaction Account and credited to the Revenue Ledger, at the times and in accordance with Schedule 1 (Pre-Acceleration Revenue Priority of Payments) (in each case only if and to the extent that the payments and provisions of a higher priority have been made in full)."

66. Both the last words of clause 11.3(a) and the opening words of Schedule 1 to the CMA make it plain that each successive payment under the scheduled waterfall can only be made when the previous higher priority payments have been paid in full. Each payment is truly subordinated to the higher priority payments, but the LFP draws attention to the fact that both those provisions refer to the Adjusted Available Issuer Income as being the fund to be applied in accordance with the subordination waterfall. In its submission, this means that the Expenses Drawings have to be drawn down before any calculation of available funds and distribution in accordance with the priorities in the Schedule. Liquidity Subordinated Amounts are then "due" because funds are available to pay them as a result of the drawdown for the Expenses Loan.
67. Reliance is then placed on clause 9.3 of the CMA, but this provides:

"In the event that there is a shortfall in the amount available to the Issuer on any Calculation Date to pay amounts due to the Issuer Secured Creditors (other than the Noteholders) on the next following Interest Payment Date, the Cash Manager will prior to a Liquidity Facility Event of Default make an Expenses Drawing under the Liquidity Facility Agreement in an amount equal to such shortfall subject to the availability of the Liquidity Facility in accordance with the terms of the Liquidity Facility Agreement and procure that the proceeds of the Expenses Drawing will be credited to the Transaction Account."

68. This provision refers to a shortfall on the Calculation Date "in the amount available to the Issuer… to pay amounts due to the Issuer Secured Creditors" (such as the LFP) on the Interest Payment Date, before making an Expenses Drawing. To my mind it is implicit that it is only if there is such an amount due before the Expenses Drawing is made that an Expenses Drawing can be made. Thus, if clause 23 has the effect for which the Issuer contends, and which is unarguably right, namely that no sum is due by way of payment of Liquidity Subordinated Amounts if there is no cash available after satisfying the higher ranking creditors, no Expenses Drawing in respect of a Liquidity Subordinated Amount can properly be made before that shortfall is assessed. The calculation must proceed on the basis that, because no drawdown is permissible, the total funds available are those without such a drawdown.

The Issuer Deed of Charge

69. This Deed provides expressly at clause 5.2 for payments to be made prior to an Acceleration Notice and for the Cash Manager on each Interest Payment Date to apply the Adjusted Available Issuer Income in accordance with the priorities set out in Schedule 1 to the CMA and otherwise in accordance with the provisions of the CMA.
70. The LFP, as one of the Issuer Secured Creditors, by clause 7.4 expressly agreed to be bound by the order of priority set out in Schedule 1 to the CMA and "notwithstanding any other provision contained herein or in any other Transaction Document" (which includes the LFA, the CMA and the Issuer Deed of Charge itself) undertook that:

"(a)Each of the Issuer Secured Creditors hereby agrees to be bound by the order of priority referred to, or set out, in the relevant Priority of Payments. Without prejudice to Clause 20 (Exercise of Certain Rights), each of the Issuer Secured Creditors (other than the Trustee) further agrees with each other party to this Deed that, notwithstanding any other provision contained herein or in any other Transaction Document:

(i) it will not demand or receive payment of any distribution in respect of, or on account of, any amounts payable by the Issuer or the Trustee (as applicable) to that Issuer Secured Creditor under the Transaction Documents, in cash or in kind, and will not apply any money or assets in discharge of any such amounts payable to it (whether by set-off counterclaim or by any other method or means), unless all amounts then due and payable by the Issuer to all other Issuer Secured Creditors ranking higher in the order of priority referred to, or set out, in the relevant Priority of Payments have been paid in full; and

(ii) without prejudice to the foregoing, whether in the liquidation of the Issuer or any other party to the Transaction Documents or otherwise, if any payment or distribution (or the proceeds of any enforcement of any security) is received by an Issuer Secured Creditor in respect of any amount payable by the Issuer or the Trustee (as applicable) to that Issuer Secured Creditor under the relevant Transaction Document at a time when, by virtue of the provisions of the relevant Transaction Document and this Deed, no payment or distribution should have been made, the amount so received shall be held by the Issuer Secured Creditor upon trust for the Trustee and shall be paid over to the Trustee or as it shall direct forthwith upon receipt (whereupon the relevant payment or distribution shall be deemed not to have been made or received). …"

71. By this clause the LFP bound itself not to seek payment of any sums as Liquidity Subordinated Amounts unless and until the higher priority payments had been paid in full and to hold on trust any sums received contrary to this principle. The same point is made in different language in clause 20.1 which reads:

"Each of the Issuer Secured Creditors agrees with the Issuer and the Trustee to be bound by the terms of this Deed insofar as applicable to their rights, claims and remedies and, in particular, confirms that, notwithstanding the provisions of any Transaction Document, no sum (whether of principal, interest, fees, costs and expenses or otherwise or any other amount due or payable to any Issuer Secured Creditor pursuant to the Transaction Documents and whether on, before or after the service of an Acceleration Notice or the Notes otherwise becoming due and repayable in full) shall be paid by the Issuer to it except in accordance with the provisions of Clause 5 (Payments out of the Issuer Accounts and Application of Cash Prior to Acceleration), Clause 6 (Payments out of the Issuer Accounts and Application of Cash Following Enforcement of the Issuer Security but prior to Service of an Acceleration Notice) or Clause 7 (Payments out of the Issuer Accounts and Application of Cash upon Acceleration), as applicable, of this Deed, unless and until all sums thereby required to be paid or provided for in priority thereto have been paid or discharged or provided for in full."

72. These provisions cannot, in my judgment, sensibly be read in any other way than that for which the Issuer contends. Under clause 7.4, the LFP binds itself not even to request payment of debts owing unless there are funds available to pay them after satisfaction of higher priority obligations. There can be no debt due if no request can be made for payment. Under clause 20.1, which prevails over all other provisions of the Transaction Documents (like clause 23 of the LFA which prevails over other provisions of the LFA) sums "otherwise becoming due and repayable in full" under the Deed are not to be paid unless all priority payments have been made. Once again that indicates that the debts cannot be due, unless payment can be and is made of the higher ranking priorities.

The Combined Effect of the LFA, the CMA and the Issuer Deed of Charge.

73. When the provisions of the CMA (and in particular clause 9.3 thereof) and the Issuer Deed of Charge (and in particular clause 7.4 thereof) are considered with clause 23 of the LFA, in my judgment, it is clear that no sum can fall due to be paid by the Issuer to the LFP in respect of that element of Liquidity Facility Increased Costs which constitute Liquidity Subordinated Amounts on an Interest Payment Date, unless there is cash available after satisfying all the higher priorities in Schedule 1 to the CMA. What cash there is beyond that can be applied to subparagraph (m) of the Schedule, to the extent possible. The parties are agreed on this, but the issue is whether the "funds available" on which the assessment is made, do or do not include Expenses Drawings to be drawn down on the basis of the obligation to pay them.
74. In my judgment the calculation of the funds available - the Adjusted Available Issuer Income – cannot include Expenses Drawings in respect of Liquidity Facility Increased Costs which are Liquidity Subordinated Amounts, because the Liquidity Subordinated Amounts are expressly not due, unless there are sums available after paying those higher ranking obligations and that has to mean sums already available before making the drawdown for the Expenses Drawings themselves.
75. The argument of the LFP to the contrary runs into a number of difficulties, in saying that, in determining whether Liquidity Subordinated Amounts are due and payable, account must be taken of the proceeds of an Expenses Drawing calculated by reference to the Liquidity Subordinated Amounts themselves. The Issuer characterised the LFP's submission as a "bootstraps" argument, because it amounted to saying that an Expenses Drawing had to be made for the Liquidity Subordinated Amounts, because, if it was made, then Liquidity Subordinated Amounts would then be due and payable under clause 23 of the LFA and clause 9.3 of the CMA. I agree.
76. Further, the LFP's submission involves the quantification of an Expenses Drawing by reference to a supposed obligation to pay it, but then not using the Expenses Drawing specifically for that purpose. The utilisation will depend on the extent of the higher ranking priorities in Schedule 1 of the CMA as set out in paragraphs 32-34 above. In the circumstances which obtain, the money drawn down would be used first in part payment of interest due on the Notes, with the balance only being paid in respect of the Liquidity Subordinated Amounts.
77. Clause 3.1(d) of the LFA provides that:

"Each Expenses Loan may be used only to make payments to the Issuer equal to any shortfall in any amounts to be paid by the Issuer on any Interest Payment Date to the Issuer Secured Creditors (other than Noteholders)."

78. The LFP submits that there is no direct hypothecation of the Expenses Loan because, whereas sub-clauses (b) and (c) of clause 3.1 state that Revenue Priority Loans and Loan Protection Loans may only be used for specific purposes, Expenses Loans (like Loan Income Deficiency Loans in sub-clause (a)) are only to equal any shortfall in any amounts to be paid. If, however, regard is had to the definition of "Expenses Loan" in the MDS as "the principal amount advanced in respect of an Expenses Drawing" and reference is then made to the MDS definition of Expenses Drawing as "a drawing to cover a shortfall in funds available to the Issuer to pay amounts due from time to time to the Issuer Secured Creditors (other than the Noteholders)", the overall effect of clause 3.1(d) is clear. If the definition of Expenses Loan is put into clause 3.1(d) instead of the words "Expenses Loan", though the clause becomes unwieldy, it is plain that the money is drawn down in order that the Issuer can pay the Issuer Secured Creditors other than the Noteholders. The point is emphasised by the form of Liquidity Facility Request set out in Schedule 4 to the LFA, where the Issuer and Cash Manager confirm that the Expenses Loan requested is to be used for the relevant purpose specified in Clause 3.1 of the LFA.
79. Yet the effect of the LFP's construction is that the Noteholders receive payment and the LFP only receives what is left after they are satisfied. There is both a deviation from the purpose of clause 3.1(d) which is payment to the LFP and not a payment to Noteholders, which is expressly negated by the sub-clause.
80. There is however one obvious oddity about the Issuer's construction. If the position is that, under the terms of clauses 23(a) of the LFA, 9.3 of the CMA and 7.4 of the Issuer Deed of Charge, no Liquidity Subordinated Amounts become due and payable, unless and to the extent that there are funds available, without any drawdown, after satisfaction of prior higher ranking creditors, there will in practice never be an Expenses Drawing for such Liquidity Subordinated Amounts. Because no sum is due if earlier priorities cannot be paid, there is no room for any Expenses Drawing to be made in order to pay the LFP. If there are funds available above and beyond the higher priorities in the waterfall, an Expenses Drawing could in theory be made in order to pay the LFP, but no such drawing is then necessary, as, ex hypothesi, there are available funds.
81. However Expenses Drawings can be made for payment to creditors other than the LFP (who rank in priority to the LFP). In Schedule 1, items (a) to (d) appear before item (e) which provides for payments by the Issuer to the LFP under the LFA of sums other than Liquidity Subordinated Amounts. Then follow items (f) and (g) followed by interest payments on the different classes of Notes as items (h)-(l). Item (m) consists of the Liquidity Subordinated Amounts payable to the LFP, with two final items thereafter. The same principle, as set out for Liquidity Subordinated Amounts, must apply equally to "all other amounts due" to the LFP under the LFA, because clause 23(a) of the LFA so provides, save that those elements rank higher at (e) as opposed to (m) in the Schedule (before payment of interest on the Notes), so that there is greater likelihood of there being funds available to meet those obligations, with lesser higher ranking priorities.
82. The debt in respect of that part of the Liquidity Facility Increased Costs which are Liquidity Subordinated Amounts, will continue to accumulate with interest until it is due, (when it can be repaid out of liquid cash available on an Interest Payment Date), should such funds be available. In the expected situation, where the LFA was to be used as a temporary facility to solve cash flow difficulties, no problem would arise. In the current situation, as explained earlier in this judgment, where repayment is problematic, to say the least, the Transaction Documents still fall to be construed according to their terms, with an eye to the most commercial construction.
83. The whole object of the LFA is to provide liquidity to the Issuer where there is a shortfall in cash to make payments of various kinds. The LFP's own increased costs (subject to the 0.125% threshold) constituting a further expense for the Issuer would not be expected to be recoverable at the expense of the fund until it was in a position to pay. That is why it ranks so low in the order of priorities in the Schedule. Although the effect is that the Issuer only pays the LFP for such costs where the cash is there to do so, after satisfying the higher ranking creditors, but does not where there is none, because no debt is due save to the extent that there is such cash available, that is the effect of providing for subordination and a Schedule of priorities. It matters not that, in practice, this means that there will never be an Expenses Drawing to obtain an Expenses Loan in respect of Liquidity Facility Increased Costs, save to the limit of 0.125% previously mentioned, as the balance will always be a Liquidity Subordinated Amount and will never constitute a debt due which can trigger an entitlement to payment on the part of the LFP unless and until there is cash available to pay it in the waterfall, when a loan will not be needed. At the end of the day, there will either be money to pay a rolled up total of Liquidity Subordinated Amounts and interest or there will not.

Conclusion.

84. In my judgment, the construction advanced by the Issuer is correct. It gives effect to the words used in the LFA, the CMA and the Issuer Deed of Charge and is consistent with the overall scheme of the Transaction Documents and the LFA in particular. The LFP's construction, by contrast, does not give proper effect to clause 23(a) of the LFA nor to the comparable provisions in the other instruments to which I have referred. LFP's construction requires an assessment to be made which is illogical and, to my mind, back to front in the context of the wording of the LFA and related agreements. It would have the effect of abrogating the purpose for which the Expenses Drawings are to be made and is not consistent with the overall scheme of subordination and priorities laid out in the documents. Although the effect of the Issuer's construction is to render redundant part of the terms of the LFA, the result is consonant with the basic principles of subordination and priorities set out and that feature of the parties' agreement is crucial in circumstances where, perhaps wholly unexpectedly, the Transaction is "broken" and there are or may be ultimately insufficient funds to satisfy all the Issuer's obligations.