'Ready To Pull The (Downgrade) Trigger Again?' Court Of Appeal Reverses Napier Decision

In May this year, we circulated an alerter on the English High Court decision Napier Park v Harbourmaster1 as to the proper construction of a ratings trigger in a CLO's reinvestment criteria. In particular, while we noted the relative clarity of the CLO's ratings trigger when compared to other provisions that we have seen, we concluded that the case demonstrates the need for particular care in drafting in this context. In an interesting reversal, the English Court of Appeal has overturned the judgment of the High Court.2

The original decision

The facts are set out in our original alerter. Put simply, the case centred on the meaning of the words "the ratings of the Class A1 Notes have not been downgraded below their Initial Ratings" in the reinvestment criteria and, in particular, whether the reinvestment criteria could ever be satisfied if the Class A1 Notes had been downgraded, even if the Class A1 Notes were subsequently upgraded to their Initial Ratings.

The High Court held that the words used were clear and unambiguous and that the phrase "have not been downgraded" indicates that something has happened at an unspecified time in the past. The High Court concluded that the intention of the parties was that the past occurrence of a downgrade could never be cured and that the reinvestment criteria could not subsequently be satisfied.

The decision on appeal

The High Court's decision was overturned on appeal. The reasons why the Court of Appeal thought that the original decision was wrong include:

The phrase "have not been downgraded" can be interpreted in more than one way - it can mean "have not been downgraded at any time in the past" or "are not presently downgraded (even though they may have been in the past)". Following the decision of the Supreme Court in Re Sigma Finance Corp3, the Court of Appeal interpreted the CLO using an iterative process - testing each interpretation and investigating its commercial consequences, and the adoption of the interpretation which is most sensible. Having regard to the overall structure, construing the reinvestment criteria as being breached by virtue of an historic downgrade that was no longer continuing would raise the effect of that downgrade "to a level of pre-dominance which it was not designed to have". In particular, the court questioned why the parties would intend for there to be a breach of the reinvestment criteria as a result...