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Natural language interpretation triumphs despite junior noteholders’ frustration with Rating Agency

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Stacey McEvoy

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20 September 2016

The claimant Note Trustee and Issuer Security Trustee (the Trustee) sought the Court's assistance interpreting a servicing agreement (in the context of a mid-2007 commercial mortgage-backed securitisation (CMBS) transaction) because of a rating agency's policy change (since October 2012, Fitch has refused to confirm that the appointment of a special servicer would not cause the downgrade of notes). The Trustee's interpretation that Fitch's confirmation was required prior to the replacement of a special servicer, despite not necessarily being the most "sensible" result, was upheld (Deutsche Trustee Co Ltd v Cheyne Capital (Management) UK (LLP) [2015] EWHC 2282 (Ch), 31 July 2015 upheld on appeal [2016] EWCA Civ 743).

The transaction followed a broadly standard CMBS transaction structure. The issuer was a special purpose vehicle only, with ongoing loan management outsourced to a third party service provider pursuant to a loan servicing agreement (the Issuer Servicing Agreement). Post-default, responsibility for active management of the defaulting loan(s) passed to a specialist recovery service (the Issuer Special Servicer).

Materially, for the purpose of this case, the notes were issued in ten classes. One or more of three rating agencies rated each class of notes: Moody's, S&P and Fitch (the Rating Agencies).

The holders of the most junior ranking class of notes with at least 25% of its original principal amount outstanding, the Class G noteholders (as the Controlling Class), were entitled to appoint a noteholder representative (as the Operating Adviser).

The Operating Adviser had certain rights, including in particular to replace the Issuer Special Servicer. However, such replacement could only take effect if each of the Rating Agencies was informed of the identity of the successor Issuer Special Servicer and, materially, "the Rating Agencies … confirmed to the [Trustee] that the appointment of the successor … Issuer Special Servicer will not result in an Adverse Rating Event, unless each class of Noteholders have approved the successor … Issuer Special Servicer… by Extraordinary Resolution". An "Adverse Rating Event" includes any downgrade, qualification, or withdrawal of the current rating by any of the three Rating Agencies.

On 10 December 2012, Fitch announced that, as a matter of policy, it would no longer provide such rating confirmations for EMEA CMBS transactions. As such, when Cheyne (in its capacity as Operating Adviser) sought to replace the Issuer Special Servicer, it was unable to obtain the confirmation sought from Fitch. Cheyne contended that the confirmation clause should be interpreted as only requiring confirmations from such Rating Agencies willing in principle to give such confirmations. The Trustee contended that the clause required confirmation from all Rating Agencies, and that absent all three confirmations, the Issuer Special Servicer could not be replaced.


Arnold J noted that the right to replace the Issuer Special Servicer was a valuable one as it enabled the noteholders to take steps to enhance their recovery. However there was an inherent potential for conflict of interest and preferences (in terms of the identity of the replacement Issuer Special Servicer) between the different noteholder classes, in light of the waterfall priority in recovery.

Arnold J agreed with the Trustee's construction, holding that the clause clearly provided that the right could not be exercised without the requisite confirmation from all Rating Agencies: as a matter of language, this was the "natural" interpretation.

Cheyne contended that the Trustee's interpretation of the clause produced the commercially absurd result that a confirmation was required from a Rating Agency that would not issue one. While agreeing that this did not appear "sensible" at first glance, the judge was ultimately not persuaded by the argument as there was an alternative mechanism to replace the Issuer Special Servicer in the second limb of the clause: that is, it could be approved by each class of noteholders. While there may be difficulties in reaching agreement between classes of noteholder, it was not improbable that there were any circumstances in which this could occur.

Separately, the Issuer Servicing Agreement included certain provisions predicated on the basis that confirmation may not be obtained from Moody's; however, it did not address the possibility that Fitch or S&P might not provide confirmation. The judge refused to interpret that clause in such a way that it would extend to the other Rating Agencies (which would have amounted to a "re-writing"), noting instead that this demonstrated that the scenario had been considered in the drafting process.

Comment: While the Trustee had no commercial interest in the outcome of the proceedings, the case demonstrates the important and active role that a Trustee may take in advocating a construction of the transaction documents in the alternative to that put forth by a certain class of noteholders: in this case it was the Trustee contending the position ultimately upheld by the court (to the benefit of more senior noteholders).

In terms of principles of general contractual interpretation, while citing and applying the most well known authorities, the case ultimately turned on the specific wording of the transaction documents and the ordinary and natural meaning of those words (following in spirit the most recent Supreme Court authority of Arnold v Britton [2015] UKSC 36).

Further information

This case summary is part of the Allen & Overy Litigation and Dispute Resolution Review, a monthly publication.  For more information please contact Sarah Garvey, or tel +44 20 3088 3710.