English Court Decision: Canary Wharf Finance II Plc v Deutsche Trustee Company Limited Et Al.

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In a very recent decision, the English High Court has provided clear support for the enforceability of a make-whole provision providing compensation to the holders of long-term fixed-rate securities in the event of an early, voluntary partial redemption by the issuer. In sterling fixed-rate note issuances, these make-whole provisions are known as "Spens" or "modified Spens" clauses. Although the outcome of the case turned on the express language of the transaction documentation, two points are of importance to the institutional investor community. First, the language used in this case is typical in similar English law governed securitisation structures. Second, the Judge in the case readily accepted the commercial common sense in holders of fixed-rate debt, particularly long-dated fixed-rate debt, being protected against opportunistic early redemptions by issuers. Introduction

The terms and conditions of long-dated fixed-rate debt securities typically include make-whole provisions that are intended to compensate holders of the securities in the event of voluntary early redemption of the securities by the issuer, as distinct from a scheduled repayment or one that is otherwise mandatory under the terms of the securities. The rationale for these provisions is to offer some protection to investors against opportunistic early redemptions by issuers. That protection is particularly important to holders of fixed-rate debt in circumstances where long-dated debt is issued and market interest rates subsequently fall. Typically, this should result in the yield on the long-dated debt rising, and the cost to an investor of replacing (following an early redemption) the fixed income that would have been earned on that debt also increasing. Investors typically expect to be protected against that risk.

Make-whole provisions included in Sterling fixed-rate bond or note issuances are typically referred to as "Spens" or "modified Spens" clauses, so named after one of the bankers - Lord Spens - who was involved in the formulation of these provisions for the Sterling bond market in the 1970s. Make-whole provisions require the issuer of the fixed-rate debt to pay an early redemption amount calculated by reference to the present value of the expected future coupons (to the scheduled redemption date) on the bond it wants to redeem. The discount rate used to determine the present value of the expected future coupons is set by reference to the redemption yield of the government debt issuance (for Sterling issues, the reference Gilt) most closely matching the scheduled maturity date of the bond to be redeemed. Depending on the interest rate at the time of the proposed early redemption, the unexpired term of the bond at the time of redemption, and the redemption yields on the reference government bond at that time, this calculation can produce an early redemption amount which is at a premium to the principal amount prepaid plus accrued and unpaid interest. Equally, though, if yields have turned negative, investors are protected by a floor on the early redemption amount of the bonds, at par for the principal amount redeemed, plus accrued and unpaid interest to the date of early redemption.

On 28 January 2016, the English High Court delivered an important decision on whether a Spens clause had been triggered under the terms and conditions of certain commercial...

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