Judgments

CoCos - Supreme Court decision in litigation between Lloyds and its noteholders

BNY Mellon Corporate Trustee Services Limited v. LBG Capital No 1 Plc and another [2016] UKSC 29

June 2016 saw the publication of the Supreme Court judgment in this case involving Lloyds Banking Group (LBG) and its attempt to redeem contingent convertible securities (CoCos) (please see our previous summary, CoCos - litigation between Lloyds and its shareholders).

In 2009, LBG issued, via two special purpose vehicles, the so-called Enhanced Capital Notes (ECNs) which were CoCos. Although the ECNs had different maturities, they could be redeemed early if a Capital Disqualification Event (CDE) took place. The dispute arose between LBG and holders of the ECNs (represented by the trustee, BNY Mellon) as to whether a CDE had in fact taken place which would entitle LBG to redeem the £3.3 billion of ECNs, which would otherwise have carried a rate of interest over 10% p.a.

The ECNs were issued in November 2009, at a time when LBG was seeking to increase its capital in order to satisfy the relevant regulatory requirements, then governed by the EU Capital Requirements Directive (CRD I).

In relation to the ECNs, a CDE was defined as including an event whereby, as a result of changes to regulatory capital requirements, the ECNs would cease to be taken into account in whole or in part for the purposes of any stress test applied by the regulator "in respect of the Consolidated Core Tier 1 Ratio".

However, the drafting of this definition did not take into account the possibility that Core Tier 1 (CT1) capital ratios could disappear as a concept, as subsequently took place under the Fourth Capital Requirements Directive (CRDIV), published in July 2013, which replaced CT1 with Common Equity Tier 1 (CET1) capital.

In December 2014, the PRA carried out a stress rest in relation to LBG's CET1 ratio. That stress test did not include the ECNs. Therefore, LBG declared a CDE and sought to redeem the ECNs early.

BNY Mellon argued that this was wrong. Firstly, because the stress test was not "in respect of Consolidated Core Tier 1 Ratio" as set out in the definition of a CDE; rather, it was a stress test in respect of a CET1 capital ratio. Secondly, BNY Mellon argued that the fact that the ECNs were not taken into account by the PRA in the December 2014 stress test was not enough to trigger a CDE; in order to satisfy the CDE definition, ECNs must be disallowed in principle from being taken into account for the purposes of the Tier 1 ratio. At first instance, the judge rejected the first of these arguments but accepted the second and found in favour of BNY Mellon that the ECNs were not redeemable. The Court of Appeal agreed as regards the first point but disagreed with the second argument and, accordingly, allowed LBG's appeal having concluded that the ECNs were redeemable.

The Supreme Court agreed with the Court of Appeal that the ECNs were redeemable. The court considered that it made no commercial sense to limit the reference to "Core Tier 1 Capital" to CT1 capital as opposed to holding that it could apply to CET1 capital; the definition should be treated as a reference to "its then regulatory equivalent" i.e. in the current context, CET1 capital. In that respect the Supreme Court noted, as had the Court of Appeal, that it was one of the essential features of the ECNs that, if necessary, they could be converted into LBG core capital, whatever expression was used to define it.

Interestingly, the Supreme Court questioned whether this conclusion even required a departure from the "literal meaning" of the definitions of "Core Tier 1 Capital" and "Tier 1 Capital"; the Court considered that, if this was the case, such a departure amounted to a rather pedantic approach to interpretation.

As regards the second of BNY Mellon's arguments, the Supreme Court agreed with LBG's position that, in light of changes to the regulatory capital requirements, the ECNs could no longer be taken into account in assisting LBG in passing the stress test.

Unusually, the case gave rise to judicial disagreement with the Majority of the Supreme Court (Lord Neuberger, President, Lords Mance and Toulson) agreeing with the Court of Appeal and Lords Sumption and Clarke dissenting. Lord Sumption considered that the ECNs, as long dated securities, cannot have been intended to be redeemed early except in some extreme event undermining their intended function and requiring their replacement with some other form of capital. The function of the ECNs was to be available to boost LBG's top tier capital in the event that the ratio of top tier capital to risk-weighted assets fell below the conversion trigger; the ECNs had, and still did, serve that function and Lord Sumption considered it irrelevant whether that function remained as important to LBG now as it had in 2009.

Lord Sumption also noted that although the case was of financial importance to the parties, it raises no issues of wider legal significance.

Skilled person not amenable to judicial review in relation to IRHP review

The Queen on the application of Holmcroft Properties Limited v. KPMG LLP (Defendant) and Financial Conduct Authority and Barclays Bank PLC (Interested Parties) [2016] EWHC 323

KPMG was appointed by Barclays as a skilled person (pursuant to section 166 of FSMA) in relation to a review agreed with the FCA, pursuant to which Barclays (and other banks) would set up a process to provide redress for customers missold interest rate hedging products (IRHPs). KPMG's role was to oversee the implementation and application of the review process, and to approve any offers of redress Barclays made. Holmcroft was offered redress as part of the review, but its claim to be compensated for consequential losses failed. It applied for judicial review, on the basis that KPMG had reached a decision on redress that was not properly open to it, having been reached via a defective process.

The court rejected, with some hesitation, the suggestion that KPMG was amenable to judicial review. The court accepted that KPMG's role was "woven into" the regulatory function, and that Barclays would not have given KPMG the extensive powers that it did, had it not been required to do so by the FCA. However, the court also noted that:

the review scheme adopted was an entirely voluntary one, and that the precise role KPMG played could not have been imposed by the FCA as part of the exercise of its powers, had Barclays not agreed to it; KPMG were appointed contractually by Barclays, not by the FCA, and that they had no relationship with those of Barclays' customers who were participating in the review; merely assisting with the achievement of public law objectives was insufficient to render a body amenable to judicial review; it was highly unlikely that the FCA could have performed KPMG's role had KPMG not agreed to do so, and it would have had to choose a different route to secure the objectives that were met by the review; and the FCA retained the ability to play an active role. The court went on to consider whether, if judicial review was available as against KPMG, Holmcroft's claim would have been made out. It decided that it would not. Holmcroft's argument rested on the fact that in deciding on an appropriate offer of redress, Barclays (and KPMG) had considered material that was not supplied to Holmcroft. The court agreed with Barclays that there was no obligation, in the circumstances, to provide Holmcroft with all of the bank's records, provided that Barclays fairly summarised the reasons for its decision (which the court found that it had).

The court declined to make any finding that potential skilled persons would be discouraged from agreeing to act, if they believed that they might be amenable to judicial review. Nonetheless, the reasoning contained in this judgment may be relevant to the FCA's appetite for appointing skilled persons directly. The judgment also provides some support for banks in the context of the IRHP review, assuming that other banks have followed a similar process to that adopted by Barclays.

Right to convert bonds

Citicorp International Ltd. v. Castex Technologies Ltd. [2016] EWHC 349 (Comm)

This claim was brought by the claimant as trustee of convertible bonds issued by the defendant. The issue to be determined was whether a conversion notice (which would have the effect of converting the bonds into equity shares) served by Castex was valid. The judge held that it was.

The judgment necessarily turns on the drafting and construction of the terms and conditions of both the bonds and the relevant notice, but it raises (albeit obiter) an issue relevant to construction generally.

There was a dispute between the parties as to whether the heading of the controversial clause in the terms and conditions of the bonds could be taken into account in construing the clause's meaning. The trustee relied on a standard provision in the trust deed (that headings were to be ignored in construing the trust deed) in order to persuade the judge that he was not entitled to take the relevant...