High Court ruling on duties of an agent bank in complex finance structure
In Torre Asset Funding Ltd & anr v The Royal Bank of Scotland  EWHC 2670, the English High Court has considered the role of an agent bank under standard contractual provisions in a structured financing and found that the ambit of the role was defined purely in the transaction documents.
The bank successfully defended claims brought by disgruntled junior mezzanine lenders after the borrower became insolvent. The court held that a contractual provision that described the agent’s duties as “solely mechanical and administrative in nature” must be read subject to specific provisions in the relevant agreements which imposed duties or conferred discretions on the agent. The role of agent, whilst not purely a “postal service” is, however, limited in nature and is not intended to include having to undertaking an evaluative analysis of whether an event of default has occurred. The judge also found, however, that the bank had assumed a responsibility for the accuracy of the explanation it offered in respect of a request for consent to the ‘rolling up’ of interest. Although the bank had (albeit not deliberately) breached its duty, the breach had not caused the defendant any loss.
Sales J considered three claims brought, unsuccessfully, against an agent bank in a structured financing to a property company, Dunedin Property Industrial Fund (Holdings) Limited (Dunedin). Dunedin became insolvent, leaving lenders at several tiers in the finance structure unpaid.
The claimants were two lenders who participated in the finance structure at the Junior Mezzanine (B1) level. The bank performed a number of roles in the structure, including that of agent at the B1 level, acting by its Property Ventures team (the PV Team). The bank also held roles, including as lender, at other tiers in the finance structure.
The finance structure involved a number of inter-related agreements, including in particular a loan facility agreement applicable to each tier of loans. The facility agreements were identical in nearly all respects save for the basic financial ratios applicable at each level, to reflect the higher protection conferred on lenders higher up the lending stack. There was also an Inter-Creditor Deed (the ICD).
The claimants claimed that:
- events occurred in 2007, that the agent was aware of, that constituted an Event of Default under the relevant agreements, and that the agent had been under a duty to notify the claimants;
- the agent should have provided the claimants with copies of a Business Plan and cash flow spreadsheet that had been provided by Dunedin; and
- in early 2008 the bank negligently misstated its reasons for seeking consent from the claimants for the rolling-up of B1 interest.
The claimants argued that, had they known of the true position, they would have sold their participations on the market or agreed some form of restructuring.
Duties of an agent bank
Central to this case was an analysis of the duties of an agent bank in a complex financing structure. The key clause in the Junior Mezzanine Facility Agreement (JMFA) concerning the agent’s duties is modelled on the standard form provision governing the role of an agent and the arranger in the Loan Markets Association’s precedent for an investment grade credit agreement, and so the court’s reasoning is of widespread interest.
Not simply a postal service
Sales J rejected the notion that the role of an agent bank was purely administrative in nature. He noted that the JMFA included a number of provisions that called for the exercise of some level of judgment or which expressly provide for an agent to give approval of various things without referring to the instructions of the lenders. The clause in the JMFA that stated that the duties of the agent under the finance documents were "solely mechanical and administrative in nature" had to be read subject to the specific provisions in the relevant agreements which imposed duties or conferred discretions on the agent.
Exercise of agent’s discretion subject to the Socimer implied term of reasonableness
Sales J found that any contractual discretion exercisable by the agent under the JMFA is limited, as a matter of necessary implication, by concepts of honesty, good faith and genuineness, and must not be arbitrary, capricious, perverse or irrational (following the Court of Appeal in Socimer International Bank Ltd v Standard Bank London Ltd  EWCA Civ 116).
Event of Default claim
There was an Event of Default
Sales J found that there had been discussions, both orally and by email, between Dunedin and the PV Team in July 2007 that constituted an Event of Default because "by reason of actual or anticipated financial difficulties" Dunedin had commenced negotiations with one of its creditors (as the bank was a lender under another layer of lending – at B2 level). Dunedin had proposed a rolling-up of interest at the B2 level. Referring to Grupo Hotelero Urvasco SA v Carey Value Added S.L.  EWCHC 1039 (in which a similarly worded Event of Default provision was considered), Sales J agreed with the claimants that the "financial difficulties" were substantial in nature, in the context of the factual matrix which included the fact that:
- the transaction was highly leveraged from the outset;
- the financial covenants were very tight;
- absent the rolling up of interest, the interest on both the B2 and M1 mezzanine lending would not be paid in full;
- the B2 interest that was to be rolled up, although relatively small compared to the overall amount of the lending, was a significant part (7-8%) of the overall amount of interest required to be serviced; and
- the inability of Dunedin to service this level of interest payment would erode the commercial value of the mezzanine lending.
Thus, the interests of the lenders was sufficiently detrimentally affected by this level of slippage, and it was therefore reasonable to infer that the parties intended such a situation to be covered by the phrase ‘financial difficulties’.
On the facts however Sales J accepted that no member of the PV Team at the bank believed that an Event of Default under the JMFA occurred in July 2007 (and nor did Dunedin), and the bank had not been "aware of any Default" under the terms of the ICD either (which would have put it under a duty to inform other agents). Sales J noted that the bank had "good grounds for believing the matter would be resolved without difficulty" and found no gross negligence or wilful misconduct in this respect.
No obligation on RBS as B1 Agent to notify claimants of Event of Default
No general obligation under law of agency: The claimants argued that the bank owed general duties at common law as an agent, including an obligation to provide relevant information to the principal (ie the claimants). Sales J rejected this, finding that the duties of the bank, as agent, were defined solely in the finance agreements.
No implied term in finance agreements: The claimants argued that a term should be implied in the JMFA that the bank, as agent for the B1 lenders, was obliged to pass relevant information about the performance of the transaction to the mezzanine B1 lenders, and that the bank was under an obligation to inform the B1 lenders of any Event of Default and of the circumstances which constituted an Event of Default. Sales J also rejected this. No such term should be implied into the JMFA because:
- it was not necessary to imply it – the parties to the JMFA would not reasonably understand that it contained such a term (applying the central test from AG of Belize v Belize Telecom Ltd  UKPC 10);
- the JMFA makes specific provision where the agent is without instructions from the lenders: "it may act (or refrain from taking action) as it considers to be in the best interest of the Lenders". The natural inference is that the parties intended that these discretions should be governed by the Socimer implied term. The claimants’ proposed implied term would therefore expressly conflict with an express term of the JMFA; and
- whether an Event of Default had in fact occurred involved making many evaluative judgments, and the wording of the JMFA suggested that the agent should not have responsibility for making such judgments.
Sales J also rejected the argument that an obligation to inform should be implied into the ICD. Again, this would require an agent to make difficult evaluative judgments before it can be said that an Event of Default has or has not occurred. This was not consistent with other provisions of the ICD which suggested that the agent was only expected to act where it is "clearly brought home" to it that something has occurred which qualifies as a specified Event of Default.
Sales J’s noted the "modest level of fee" charged by the bank for its services as agent (GBP 15,000 pa), and felt this was consistent with the role of an agent not having to include making substantive evaluative judgments, but rather being generally limited to a more administrative one.
Difficult to imply terms into complex finance structures
Sales J reiterated that the case concerned complex interlocking financial transactional documents, involving multiple parties and potential changes in the identities of the parties from time to time when interests are syndicated or sold on. As such, certainty, clarity and predictability are of the utmost importance when considering whether a term should be implied into an arms length commercial agreement.
Business Plan claim
This claim also failed. The bank was only under an obligation under the JMFA to transmit onwards to the B1 lenders the Annual Budget from Dunedin. Sales J found that the Business Plan and October cashflow, provided by Dunedin in October 2007, was not the Annual Budget. The bank was under no obligation to chase Dunedin to ensure it provided a proposed Annual Budget, nor was it under any obligation to inform the claimants of any failure by Dunedin to provide one.
The bank, as agent, was not under an obligation to pass onto the claimants all financial information received from Dunedin.
Negligent misstatement claim
Sales J found that when the bank (in its capacity as B2 lender) had provided an explanation as to why the claimants’ consent was sought for the B2 interest to be fully rolled up to maturity, with the object of persuading the claimants to give their consent, the bank assumed responsibility for the accuracy of that explanation such as to owe a duty of care to the claimants (Hedley Byrne v Heller & Partners  AC 465). The bank "did not have to speak, but chose to do so". Furthermore, nothing was said on behalf of the bank that indicated that it was not assuming responsibility for the accuracy of the explanation.
The situation in which the explanation was given was not covered by the JMFA or the ICD as it was given to induce the claimants to take action which would enable the financing arrangements to be changed. Sales J held that the JMFA and ICD did not purport to determine the respective responsibilities of, and risk assumed by, a lender seeking consent to a variation of the financing arrangements and a lender from whom such consent is sought.
Sales J held that the bank had negligently misstated why Dunedin had requested the interest roll-up. The bank had asserted that the reason for the request was to enable Dunedin to retain cash to spend more on capex to improve the quality of the property portfolio. The bank should have explained that the main reason for the request was that the bank and Dunedin predicted that, absent rolling up, there would be difficulties servicing the debt. Sales J recognised that there was no suggestion of any deliberate lies, and in fact a cashflow provided by the bank to a different lender revealed the true picture (thus reinforcing the fact that this was not something the bank was seeking to hide).
The negligent misstatement claim failed because of the limits upon the scope of the duty of care. As the claimants did not seek the explanation for the purpose of conducting a wider review of their involvement in the transaction, the bank did not volunteer the explanation for that purpose either. The bank only assumed an obligation to exercise reasonable care to protect the claimants against such loss as they might suffer by reason of giving their consent to the rolling up of the B2 interest. However, they suffered no loss. Although they gave their consent, other lenders did not, so the proposed roll up plan did not take effect.
Although obiter (given his conclusions above) Sales J also considered other defences raised by the bank including on exclusion clauses and causation. Of particular note was Sales J’s observation that:
- there was a "contractual estoppel" provision in the JMFA which entitled the agent to assume no knowledge of a default unless notified about one in its capacity as agent, save where the agent has actual knowledge of non-payment. This provision had a valid commercial objective, according to Sales J, as it precluded any need for argument about the agent’s state of mind; and
- Sales J held that the exclusion clauses in the JMFA would apply to both acts and omissions. The clauses would have protected the bank, as agent, in relation to the event of default and business plan claims, but would not have protected the bank, as lender, from the negligent misstatement claim.
Sales J’s lengthy and comprehensive judgment in this case will be, unless overturned on appeal, considered to be an important guide for all who are involved with complex finance structures. Obviously each transaction will depend on the wording of its contracts, but this case (involving standard LMA wording) confirms the limited role of an agent bank. Whilst not merely a post-box, neither is an agent expected to have to make evaluative decisions about whether a default has occurred. Here, the agent was not aware of any Event of Default. As Sales J comments, obiter, had it received notice of a Default from Dunedin or another agent, a failure to pass that notice onto lenders might well "amount to gross negligence". This would have removed the protection afforded by the exclusion clauses (which apply unless the action is caused by "gross negligence or wilful misconduct".)
Another point to note is that a bank must be cautious when stepping outside of the contractual structure to offer opinions/explanations. Even where there is a carefully documented deal, there is a risk of assuming a duty of case in such circumstances.
The case also highlights the multitude of roles that can be held by a finance party in a financing structure – including agent, lender, note holders etc. A bank must have careful systems in place so that it knows in what capacity it is receiving information from other agents, lenders or a borrower, as the capacity in which it receives that information can affect its obligations on what to do with it.
Finally, those involved with the drafting and negotiation of similar finance agreements will want to consider ensuring that exclusion clauses cover both acts and omissions, to avoid any argument on the point in any later dispute.