Court of Appeal dismisses claim by participant against lender of record in a sub-participation arrangement

The Court of Appeal has dismissed a claim by a participant against the lender of record in a sub-participation arrangement under a master participation agreement, rejecting the participant's argument that the contractual arrangements in question amounted to a fixed term loan: Yieldpoint Stable Value Fund, LP v Kimura Commodity Trade Finance Fund Ltd [2024] EWCA Civ 639.

Lenders will welcome this decision, which overturns a controversial High Court ruling in which the grantor of the sub-participation was ordered to repay the participant's capital investment and unpaid interest when the underlying borrower defaulted (see our previous blog post). As a reminder, in a typical funded participation arrangement a lender under a facility agreement enters into a back-to-back funding arrangement in respect of 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 the lender of record. Typically, a participant would only have recourse to the underlying borrower and any credit support granted in relation to the underlying loan, and would therefore be exposed to the double credit risk of both the borrower and grantor of the sub-participation. Market standard documentation is often used, but arrangements can also be very bespoke.

In the present case, the underlying borrower defaulted on its obligations under the facility. The participant sought to recover its capital investment plus interest from the grantor of the sub-participation, arguing that the contractual arrangements amounted to a fixed term loan, not a sub-participation arrangement. The Court of Appeal was tasked with interpreting the contractual documentation relating to the sub-participation to ascertain whether it was a conventional sub-participation or a fixed term loan.

Both the High Court and Court of Appeal relied on the principle in Lloyds TSB Bank Plc v Clarke [2002] UKPC 27 that using the label of "sub-participation agreement" is not sufficient to dictate the legal rights and duties created by the contract. Both courts also agreed that "strong and clear" language was required on the facts of this case in order to depart from the default sub-participation structure provided by an umbrella master participation agreement between the parties. However, while the High Court found that the inclusion of a "Maturity Date of the Participation" in the agreement was sufficient, in the Court of Appeal's view, this single provision could not be read as changing the nature of the transaction from a conventional sub-participation to a fixed term loan. The key factors influencing the Court of Appeal's decision were: (i) the nature of the agreement; (ii) the contractual language; (iii) the context of the parties' negotiations; (iv) the countervailing provisions in the contractual documentation; and (v) whether the competing interpretations of the contractual documentation made commercial sense.

We examine the decision in more detail below.

Background

The background to this case is more fully set out in our blog post on the High Court decision, here.

In summary, Yieldpoint Stable Value Fund, LP (Yieldpoint) had agreed to pay USD 5 million to Kimura Commodity Trade Finance Fund Ltd (Kimura) to participate in Kimura's 50% share of an existing loan facility extended to a third-party company. The agreement (the MTV Participation) was made pursuant to and expressly incorporated the terms of a Master Participation Agreement for Trade Transactions (the MPA).

The company defaulted on its obligations under the facility. A dispute subsequently arose between Yieldpoint and Kimura as to the nature of the MTV Participation. Yieldpoint contended that, properly interpreted, the MTV Participation was a fixed term loan from Yieldpoint to Kimura, repayable in full by Kimura on the maturity date regardless of any default in the meantime by the company. In particular, Yieldpoint relied on the addition in the MTV Participation of a "Maturity Date of the Participation" of 31 March 2022 and Special Conditions providing for Yieldpoint to give prior notice if it intended to renew its participation. Kimura, on the other hand, argued that the MTV Participation was a sub-participation in the facility, meaning that Yieldpoint would share in both the risk and reward of the loan.

High Court decision

The High Court's reasoning is discussed in our previous blog post, here.

In summary, the High Court found in favour of Yieldpoint. It held that the MTV Participation was a fixed term loan and not a true sub-participation in the facility. The court ordered that judgment be entered for Yieldpoint against Kimura in the principal sum of USD 5 million, with interest to be determined.

Kimura appealed to the Court of Appeal.

Court of Appeal decision

The Court of Appeal found in favour of Kimura and allowed the appeal. It held that the MTV Participation was a conventional sub-participation. As the company had defaulted prior to the maturity date, Yieldpoint was not entitled to be repaid its USD 5 million investment.

The key issues which will be of interest to financial institutions are set out below.

Principles of contractual interpretation

The Court of Appeal underlined that, as per Lloyds, the fact that the parties have labelled their agreement a "sub-participation agreement" does not necessarily dictate the legal rights and duties created by the contract. These are a matter of construction for the court, and whether they should be regarded as having a particular legal character is a question of law (as per Street v Mountford [1985] UKHL 4).

The Court of Appeal noted that the MTV Participation should be interpreted according to the well-established principles in Rainy Sky SA v Kookmin Bank [2011] UKSC 50 and Wood v Capita [2017] UKSC 24), in particular:

• The contractual interpretation process is a unitary exercise involving an iterative process by which each suggested interpretation is checked against the provisions of the contract and its commercial consequences.
• While evidence of the parties' intentions or their negotiations is inadmissible, evidence of the factual background known to the parties at or before the date of the contract, including evidence of the 'genesis' and objectively the 'aim' of the transaction, is admissible.

Proper interpretation of the MTV Participation

The Court of Appeal observed that the MTV Participation was a single trade made pursuant to and expressly governed by the terms of the MPA, an umbrella agreement designed to save the parties from having to renegotiate and re-state the detailed terms of their trades on each occasion. Indeed, the MTV Participation, made on the template annexed to the MPA, only made sense if read together with the MPA.

On this basis, in the court's view, it was inherently unlikely that the parties intended that the MTV Participation would not resemble or replicate a conventional sub-participation. Had the parties intended to make an entirely different type of deal, such as a simple unsecured fixed term loan, they would surely have abandoned the MPA structure and template and executed a separate loan agreement with terms and conditions to be expected in such an agreement.

The Court of Appeal considered whether the inclusion of the "Maturity Date of Participation" involved sufficiently strong and clear wording to depart from the default sub-participation structure, focusing on the following key factors:

• Contractual language. The Court of Appeal did not consider the concept of a "Maturity Date of the Participation" could be read as indicating an intention to overturn the entire structure and effect of the umbrella agreement stated to govern the MTV Participation and to require modification of many terms and certain provisions in the MTV Participation.
• Context of negotiations. The Court of Appeal considered the context of the parties' negotiations. It highlighted that it had considerable doubts as to the admissibility and relevance of those matters, being a classic case of parole evidence (which is usually inadmissible). However, it said that even if aspects of the negotiation were admissible to show that the genesis or aim of the transaction was a "fixed term" deal and that Kimura would "pay back" Yieldpoint on 31 March 2022, these oral exchanges did not add anything to the written agreement. Further, those discussions should be considered against the backdrop of the contractual documentation, which contained an express warning that Yieldpoint's capital was at risk.
• Countervailing provisions. The Court of Appeal considered the countervailing provisions in the MPA and the MTV Participation itself. It said that these provisions could not be overridden by the single term "Maturity Date of Participation". It highlighted that the correct approach was first to seek to read all the contractual provisions together, in order to reach a coherent interpretation of the entire contract which conforms with commercial sense. Based on this approach, it was difficult to see that the MTV Participation, in the context of the MPA, could be read as anything other than a conventional sub-participation agreement with early redemption. Potential difficulties with the mechanism of redemption did not justify overturning everything else in the parties' carefully structured deal.
• Commercial sense. The Court of Appeal considered the commerciality of each of the competing interpretations of the contract. It said that Yieldpoint's interpretation undermined the commercial sense of the structure set out in the MPA.

The Court of Appeal concluded that the inclusion of a Maturity Date did not change the nature of the MTV Participation from a conventional sub-participation to a fixed term loan. As the company had defaulted prior to the Maturity Date, Yieldpoint was not entitled to be repaid its USD 5 million investment.

Accordingly, for all the reasons above, the Court of Appeal found in favour of Kimura and allowed the appeal.

Note: In November 2024, the Supreme Court refused Yieldpoint's application for permission to appeal.