High Court finds express terms of sub-participation agreement took precedence over framework master agreement

The Commercial Court has found that the express terms of a sub-participation agreement negotiated by the parties took precedence over the terms of a framework master agreement, leaving the lender of record liable to repay the participant's capital investment when the underlying borrower defaulted: Yieldpoint Stable Value Fund, LP v Kimura Commodity Trade Finance Fund Ltd [2023] EWHC 1212 (Comm).

Sub-participation is well-known in syndicated lending. In a typical funded participation arrangement, which is often documented using market standard documents, a lender under a facility agreement subcontracts all or part of its participation in the loan to another party, and so mitigates the risk of default by the underlying borrower while remaining lender of record. Typically, a participant is exposed to the double credit risk of both the borrower and grantor of the sub-participation. However, arrangements can also be very bespoke, and entered into for a variety of reasons.

In the present case, as a matter of contractual construction, Stephen Houseman KC (sitting as a judge of the High Court under the shorter trials scheme) held that the parties used sufficiently clear language to create a hybrid form of sub-participation, which insulated and protected capital while sharing risk and reward on a pari passu basis in respect of income earned on such capital during an agreed fixed term. Accordingly, in circumstances where the borrower had defaulted under the underlying loan, the grantor of the sub-participation was ordered to repay the participant's capital investment, plus interest. This was despite the fact that a framework master agreement provided template documentation which envisaged that any future individual participation agreement would be a conventional pari passu sub-participation (where the participant would assume a capital default risk in respect of the borrower). The defendant lender has applied to the Court of Appeal for permission to appeal the decision.

This decision will be of interest to financial sector clients as it reinforces the principle that there is no fixed concept of sub-participation as a matter of English law or international financing practice, as articulated by the Board of the Privy Council in Lloyds TSB Bank plc v Clarke & Anor [2002] UKPC 27. Using the label of sub-participation is not sufficient for an arrangement to be construed legally as a "typical" funded sub-participation arrangement.  The effect of the agreement will depend on the contractual terms agreed. The decision also introduces the possibility of a novel "hybrid" form of sub-participation, not previously recognised in the case law.

More generally, this judgment demonstrates the general risks of entering into agreements based on templates pursuant to a master agreement, without considering carefully the effect of any bespoke terms which may diverge from the standard terms of the master.

Following this judgment, the court considered the impact of the claimant's Part 36 offer, ruling that the very high offer deprived the claimant of the usual costs benefits, as it was not a genuine attempt to settle (see our Litigation Notes blog post).

Background

Kimura Commodity Trade Finance Fund Limited (Kimura), together with an entity in the Anglo-American group (AAML) had for some years provided pre-export commodity finance to Minera Tres Valles SPA (MTV), a copper-mining and cathode-producing company incorporated and based in Chile.

Kimura and AAML were joint senior lenders to MTV under a US$45m four-year structured finance facility (the MTV Facility). This facility was fully funded at all material times. Kimura’s share of the MTV Facility was US$22.5m.

In 2021, Kimura entered into a sub-participation arrangement with Yieldpoint Stable Value Fund LP (Yieldpoint). The parties signed a framework Master Participation Agreement (MPA), which was based on or comprised the Bankers Association for Finance and Trade standard form at the time. The MPA anticipated that the parties would enter into future individual participation agreements, in line with the MPA's template documents. The MPA envisaged that any participation agreement would be a conventional pari passu sub-participation (ie Yieldpoint's capital and income stream would be exposed to primary default risk). The MPA also stated that any inconsistent or conflicting terms of the MPA would be overridden or modified by the express terms of any participation agreements.

As contemplated by the terms of the MPA, the parties subsequently executed a participation agreement to provide funding specifically in respect of the MTV Facility (the MTV Participation). The relevant terms of the MTV Participation were:

1. a "Participation Amount" of US$5m and a corresponding "Retention Share" of US$17.5m; and
2. a fixed term of 364 days, ie until the "Maturity Date" of 31 March 2022 (in contrast to the MTV Facility which continued to run until 31 December 2024), with a Special Condition setting out a mechanism to give Yieldpoint an option to extend beyond the Maturity Date by giving 45 days' notice.

The first capital tranche under the MTV Facility was due on 31 March 2022. However, MTV defaulted and was declared bankrupt by a Chilean court in February 2023.

Yieldpoint gave notice of its intention not to renew the deal with Kimura on 10 February 2022, but Kimura did not repay the principal sum to Yieldpoint on the Maturity Date.

Kimura contended that the transaction was a capital risk investment by way of pari passu participation as economic stakeholder in Kimura’s share of the MTV Facility, ie a conventional proportionate sub-participation, and therefore Yieldpoint’s capital was exposed to the underlying default risk.

Yieldpoint contended that the MTV Participation protected its capital in that it was only subject to default risk of its own contractual counterpart, Kimura (and not MTV), whilst sharing risk and reward on a pari passu basis in respect of income earned on such capital during the agreed fixed term.

Yieldpoint commenced proceedings, seeking repayment of the US$5m principal which it advanced to Kimura.

Decision

The court held that Yieldpoint's claim for payment of the principal sum succeeded, together with interest since 31 March 2022 (ie the Maturity Date).

General comments on sub-participation and the MPA

The court noted that there was no fixed concept of sub-participation in English law, referring to the case of Lloyd’s TSB Bank v Clarke and the approach of Lord Hoffmann, who held that the label was not conclusive:

"…the fact that the parties labelled their agreement a 'sub-participation agreement' did not necessarily mean that it had to have the legal consequences described by Mr Wood and the Bank of England. The legal rights and duties created by the contract were a matter of construction for the court. Whether those legal rights and duties, as ascertained by construction, should be regarded as having a particular legal character was a question of law...The label was not conclusive. Nor was it conclusive as to whether a transaction fell within a particular market category."

That said, the court observed that the "standard concept" of sub-participation (which was also reflected in the MPA), "involves a proportionate sharing of both risk and reward in the relevant underlying finance. This entails exposure of both capital and income stream (ie interest and/or revenue-sharing) to primary default risk".

The court said that only clear language could significantly alter the nature of the default structure (both in general and as contemplated by the MPA). The more significant the departure, the clearer and stronger the language needed. In the court's view, it was inherently unlikely (although not impossible) that the parties intended to make a specific trade pursuant to the terms of the MPA which did not resemble or replicate a conventional sub-participation.

Analysis of the MTV Participation

The court commented that Yieldpoint's construction of the MTV Participation involved a significant alteration to and departure from the conventional sub-participation model. It involved a hybrid form of sub-participation, insulating and protecting capital (subject only to default risk from its own contractual counterpart, Kimura) whilst sharing risk and reward on a pari passu basis in respect of income earned on the capital during the agreed fixed term. In the court's view, this required a bright line to be drawn between capital and income. In effect, Yieldpoint's characterisation was partially a fixed-term loan (as to capital) and partially a participation (as to the interest and “price participation” payments to be received from the underlying borrower).

The court said that the parties had not identified any decided case in which such a hybrid form of sub-participation was involved or even mentioned, nor any case which says it cannot happen. Accordingly, the court applied the test from Lloyds TSB v Clarke (above).

The court commented that each side’s analysis had its own problems, but ultimately accepted Yieldpoint's hybrid sub-participation characterisation, albeit "not without some discomfort" and involving "a significant degree of linguistic surgery". There were two principal stages of the court's analysis.

1. Modification of the terms of the MPA

Assuming that the parties used sufficiently clear language to create a hybrid form of sub-participation, the court considered whether the terms of the MPA could be modified or overridden to make sense of that arrangement. Having considered various definitions in the MPA, the court concluded that it could be modified or changed to capture this form of hybrid sub-participation.

2. Did the parties use sufficiently clear language in the MTV Participation to create a hybrid form of sub-participation?

The court found that the parties did use sufficiently clear language to create a hybrid form of sub-participation, despite using the template documentation provided by the MPA. The key factors considered by the court in reaching this conclusion were as follows:

• The inclusion of a maturity date. Crucial to the court's analysis was the inclusion of the 12-month fixed term "Maturity Date" in the MTV Participation, which (together with the Special Condition relating to renewal below) were sufficiently strong and clear to depart from the pre-ordained sub-participation structure. The court noted that the concept of a maturity date itself is "alien" to sub-participation, whereas it is normal for a fixed-term loan, where the lender takes the default risk of the borrower only. Further, the concept of a maturity date led Kimura to formulate an argument around the "exit regime" at maturity. This was based on alleged implied terms, which the court described as "the most telling point against [Kimura's] interpretation of the MTV Participation".
• The renewal notice period in the contract. The Special Condition in the MTV Participation created a renewal regime (the mechanism giving Yieldpoint an option to extend beyond the Maturity Date by giving 45 days' notice). The court said that this was always proposed to be a "fixed term" deal. Kimura's implied "exit regime" would also have subverted this negotiated renewal in the Special Condition.
• A verbal assurance by Kimura to repay the funds. On the evidence, the court found as a matter of fact that Yieldpoint was assured it would get its capital back after one year. Yieldpoint's own need for the return of this capital to meet upstream redemptions drove the inclusion of the maturity date and renewal notice provisions discussed above.

Accordingly, the court concluded that Kimura had an unconditional obligation to repay the sum of US$5m to Yieldpoint on 31 March 2022 and that it had breached that obligation. Kimura was therefore liable in debt (alternatively damages) together with interest from 31 March 2022.

Note: In June 2023, the defendant applied to the Court of Appeal for permission to appeal.

In October 2023, the Court of Appeal allowed the defendant's application for permission to appeal. The Court of Appeal hearing has been floated for 24/25 January 2024.