Business common sense arguments fail to save unclear drafting: the Court of Appeal (UK) upholds High Court decision on loan repayment fees

BMA Special Opportunity Hub Fund Ltd & Ors v African Minerals Finance Ltd [2013] EWCA Civ 416 (read the judgment here)

The Court of Appeal has upheld a High Court decision construing a finance agreement such that a borrower’s prepayment of a loan facility following a voluntary refinancing with another lender did not trigger a prepayment fee provision in the agreement.

In doing so, the Court has re-emphasised the importance of the contractual wording when construing commercial contracts and provided further guidance on the extent to which considerations of "commercial common sense" should be taken into account.

We previously reported on the first instance decision of Mr Justice Eder in Aston Hills Financial Inc & ors v African Minerals Finance Ltd [2012] EWHC 2173 (Comm). Click here to read our detailed briefing.

The dispute concerned the scope of a clause in a facility agreement entitling the Lenders to a prepayment fee in the case of voluntary early repayment. In particular, at issue was whether that provision was triggered in the circumstances of a prepayment by the borrower following a refinancing.

The judge at first instance had concluded, based on an analysis of the contractual wording, that the prepayment was not "voluntary" and therefore did not fall within the fee provision and that no fee was payable. The Lenders appealed.

Key points

• The Court of Appeal confirmed that the starting point for contractual construction is the wording the parties have used. While considerations of business common sense may assist a court in choosing between competing available constructions, such considerations 'are not to be elevated to an overriding criterion of construction' and a judge should not impose upon the parties his or her 'own notions of what might have been a sensible solution to the parties' conundrum'.
• Considerations of "business common sense" in the context of contractual construction should not be confused with the question of what might have been good business sense for a particular party. A particular result may make commercial sense on the basis of an assumption that it was the outcome of compromise and negotiation - particularly where the parties are well-advised commercial entities who negotiated the agreement in detail.
• The Court of Appeal's decision that no prepayment fee was payable in respect of a prepayment following a voluntary refinancing might at first blush be surprising and concerning to the banking industry. However, that conclusion was based on an analysis of the particular wording of the contractual provisions in this case, which the Court of Appeal considered were not clearly drafted. It is therefore not the case that every prepayment provision will be construed in the same way as the one in this dispute.

The issue

The dispute essentially centered on the interaction of the following provisions of the agreement:

• a relatively standard voluntary prepayment provision allowing the Borrower to prepay the whole or part of the loan before the full term (clause 8.5);
• a provision imposing a prepayment fee of 6% upon any prepayment made 'pursuant to clause 8.5' ('the fee provision'); and
• a mandatory prepayment provision obliging the Borrower to prepay the loans in an amount equal to any finance proceeds it obtained (clause 8.3).

At issue was whether the Borrower's prepayment of the loan following a voluntary refinancing with another lender was a prepayment 'pursuant to clause 8.5' and therefore triggered the fee provision.

The first instance decision

A large portion of the argument before Mr Justice Eder at first instance consisted of the parties' submissions as to why their preferred interpretation of the provision was the more consistent with business common sense. However, after considering those submissions at some length, Eder J concluded that the arguments were evenly balanced and did not point clearly in favour of one construction or the other. In other words, it was not the case that there was a single compelling case as to what the commercial common sense interpretation should be which would assist in the construction of an ambiguously drafted clause.

Eder J therefore returned to examining the wording of the clauses and, as a matter of literal construction, concluded that no prepayment fee was payable. While accepting that the refinancing had been voluntary, he refused to conclude that the consequent prepayment itself could therefore also be characterised as voluntary and be regarded as a payment falling within the voluntary prepayment provision (in addition to the finance proceeds provision). As the fee provision was, on its wording, expressly limited to payment under that voluntary prepayment provision, no fee was payable. Notably, Eder J acknowledged:

'I should emphasise that I remain very uncertain whether this conclusion accords with business common sense… However, …the conclusion which I have reached is one which, in my judgment, is more consistent with the language used ...' (at paragraph 35).

The Lenders' (appellants') case

As expected, the Lenders emphasised Eder J's conclusion that the arguments between the parties on construction were "finely balanced" and argued that his final decision ought to have been based more on an assessment of which construction was more consistent with “business common sense”.

In this regard, it was the Lenders' view that the "business common sense" was that the purpose of the prepayment fee was to compensate the Lenders for interest payments that would be lost if the loan were voluntarily prepaid early. The Lenders also relied heavily on the point raised at first instance that, on the Borrower's construction, a prepayment fee would only be payable if the Borrower repaid the loan using its own funds. Thus the pre-payment fee could be easily avoided by re-financing the loan rather than using its own funds to make a prepayment. The Lenders submitted that this was "uncommercial" because, at the time the loan was made, it was "inconceivable" that the Borrower would be able to repay the minimum repayable amount of the loan (in this case USD100 million) without refinancing. Hence, the circumstances in which a prepayment fee would be payable were very narrow.

The Lenders therefore argued that, in these circumstances, the first instance judge's reasoning had been flawed. In particular, insufficient attention had been paid to a clause which prohibited the Borrower or its parent from incurring or having any Financial Indebtedness (i.e. refinancing) to others without the prior written consent of the Facility Agent. The Borrower did not obtain that consent and therefore it followed that its decision to prepay (and so the decision to obtain the Refinancing Facility) was voluntary, in the sense of having been done with deliberate intent. Accordingly the voluntary prepayment provision was the operative one.

The Court of Appeal decision

Approach to contractual construction

In outlining the Court's approach to the task of construing the contract, Aikens LJ (giving the sole judgment) stressed that the starting point was the wording of the document itself and the principle that the commercial parties who agreed the provisions intended the words used to mean what they say.

He noted that, where there are two possible constructions of the document, a court is entitled to prefer the construction which is more consistent with “business common sense,” if that can be ascertained (as clearly articulated by the Supreme Court in Rainy Sky SA and others v Kookmin Bank [2011] UKSC 50). However, notably, he went on to state:

'However, I would agree with the statements of Briggs J, in Jackson v Dear [(2012) EWHC 2060 at 40] first, that “commercial common sense” is not to be elevated to an overriding criterion of construction and, secondly, that the parties should not be subjected to “…the individual judge’s own notions of what might have been the sensible solution to the parties’ conundrum”. I would add, still less should the issue of construction be determined by what seems like “commercial common sense” from the point of view of one of the parties to the contract.' (at paragraph 24)

The relevant background here identified by the Court of Appeal was that the parties to the contract were commercial entities who employed experienced commercial lawyers to negotiate the terms in very great detail over a period of three months and therefore it was unlikely that any mistakes had been made. The loan documentation contained various clauses and sub-clauses dealing with the circumstances in which prepayment of the loan might be made. In the context of a heavily negotiated loan agreement, it appeared (on an objective assessment) that the parties intended that each of those types of prepayment arose under different and distinct circumstances.

Decision

The Court of Appeal rejected the appeal and affirmed that the first instance judge had been correct to conclude that the decision to obtain the Refinancing Facility and the requirement to use the proceeds of that refinancing to prepay the Loan in full were two separate matters.  It did not follow from the fact that the first decision was “voluntary” (in the sense of being intentional) that the prepayment was therefore also “voluntary”. Once this was established, the Court of Appeal considered that the construction of the prepayment provisions became much easier. After refinancing the Loan, the Borrower was contractually obliged to use that sum to prepay the Loan. To characterise the prepayment as “voluntary” in the face of that contractual obligation was an abuse of language.

As to the "commercial common sense" argument, the Court of Appeal observed that a focus of the negotiation between the parties would have been the terms dealing with the circumstances in which a prepayment fee would be payable: with the Borrower and Lender having directly competing interests as to how wide this provision should be.

The Court of Appeal also noted that there were other clauses in the contract which placed restrictions on the circumstances in which the Borrower would be entitled to prepay the Loan voluntarily. These restrictions indicated that the parties fully appreciated that a partial prepayment would come from the Borrower's own funds but that a total voluntary prepayment by the Borrower from its own funds would be out of the question. Such restrictions were absent from the mandatory prepayment provisions. If the parties had wanted to provide for a prepayment fee when part or the entire Loan was prepaid as a result of a refinancing, this could have been easily achieved in the drafting of the contract.

In the Court of Appeal's view, there was no lack of commercial common sense in a decision by the parties "doubtless after much negotiation" to provide for the payment of a prepayment fee in only limited factual circumstances. That position reached was "the essence of 'commercial common sense' ".

Commentary

The Court's analysis of the provisions

It may be a surprise to the banking community that a borrower's decision to refinance a loan did not constitute a voluntary prepayment giving rise to a prepayment fee. At first blush, the decision might be seen as a potential cause for concern to lending banks insofar as it appears to suggest that prepayment provisions, which are widely used in loan documentation, are at risk of being interpreted by the Courts more narrowly than what might have been envisaged by lenders when such documentation was agreed. In this case, the Lenders were denied a prepayment fee of around USD17 million.

However, the Court of Appeal's decision was the result of a rigorous analysis of the specific contractual documentation in dispute. In reaching its decision, the Court of Appeal was mindful of the fact that the documentation had been heavily negotiated by six teams of lawyers and that, on an objective assessment, it appeared that "the parties did not intend to leave anything to chance and intended the terms to be as precise as possible…".

The Court of Appeal also relied on the terms of other clauses which pointed to the fact that the parties appreciated how the voluntary prepayment provisions worked. In other words, the relevant background was unhelpful to the Lenders in that the Court of Appeal was unwilling to accept, on an objective assessment, that a mistake might have been made.

However, it appears from the judgment that the Court of Appeal was less than impressed by the drafting of the clauses dealing with early prepayment (and the circumstances in which a prepayment fee would be payable). Indeed, in obiter comments the Court suggested a number of ways in which the drafting of the prepayment provisions could have been improved to achieve the result for which the Lenders were contending. The Court also noted typographical errors in the loan documentation, such as the misuse of plurals.

In short, the drafting of the loan documentation was far from perfect. Therefore, whilst prepayment provisions are common in loan documentation of this nature, it is not the case that every prepayment provision will be construed in the same way as the one in this dispute.

The approach to construction – the role of business common sense

In our briefing of the first instance decision, we noted that a distinction can be drawn between two categories of case:

• Non-ambiguous provisions- where there is only one clear literal meaning of the language used but one party asserts that the parties did not in fact intend it to have that meaning, by pointing to the non-commerciality of the result. In such cases, a court will generally only be justified in departing from the literal meaning where the result would be so absurd and commercially nonsensical that it could not possibly be what the parties agreed; and
• Ambiguous provisions - where the words used are reasonably capable of bearing more than one interpretation. In such cases 'the Court is entitled to prefer the construction which is consistent with business common sense and to reject the other' (Rainy Sky).

Although the first judgment was upheld, the Court of Appeal reached its decision on the basis of a different analysis. The first instance judge was of the view that the prepayment provisions were ambiguous but that there was no single compelling "commercial common sense" interpretation to assist the Court in choosing between the competing interpretations (hence why Eder J reverted to a literal approach). On the other hand, the Court of Appeal concluded that, upon proper analysis, the drafting of the clause had one clear literal meaning which was not ambiguous. The fact that no prepayment fee became payable upon the Borrower's refinancing made perfect commercial sense (however unfortunate that might have been for the Lenders).

The Court of Appeal's judgment is therefore consistent with the now relatively established approach to the role of business common sense in construing commercial contracts - including the distinction between the treatment of ambiguous and non-ambiguous clauses. However, the decision serves to highlight the fact that applying those established approaches is rarely a straightforward exercise and that the extent to which business common sense will be taken into account in any particular case will depend upon a court's view as to whether the contractual language is in fact ambiguous.

The message therefore remains that clear drafting is paramount and that commercial parties should not assume they will be able to avoid the repercussions of poor drafting by arguing that the result lacks commercial sense. As this case illustrates, if a Court takes the view that the wording of a contract does, on its face, carry a sufficiently clear meaning, it can and will hold the parties to the words they have agreed - particularly where the contract has been fully negotiated by well-advised commercial entities.