High Court considers interpretation of intercreditor deed of priorities

A High Court Master has allowed a summary judgment application by a junior lender. The application was made in the context of a dispute between a junior lender and a security agent for a senior lender as to the proper interpretation of an intercreditor deed of priorities (ICD): Mayfair Capital Residential 2 LLP v Reim Katch Securities Ltd [2024] EWHC 1920 (Ch).

An intercreditor arrangement is made between multiple creditors to govern the terms of their relationship, particularly in relation to the priority of their claims against a common borrower group. Typically, the risk allocation favours the senior lenders, but ultimately the terms of any intercreditor arrangement are a matter of negotiation between the parties. Often certain "permitted payments" may be made by the borrower group to the junior creditors, notwithstanding the overarching order of priority of application of proceeds on enforcement of the security. These will be contractually expressly permitted in the intercreditor agreement or deed, and usually relate to payments of interest on the junior debt, for example.

In this case, the ICD included an unusual "permitted payments clause" (in fact, more akin to a "priorities clause"), which provided for fairly significant payments to be made to the junior lender from the net proceeds of sale of any of the common pool of secured assets (luxury flats), up to a maximum total amount. The question was whether this clause continued to apply after the appointment of a receiver, or whether the usual application of proceeds clause should apply in its place.

The Master employed a strict approach to contractual interpretation and found that the permitted payments clause did continue to apply after the appointment of a receiver. In circumstances where the clause in question was widely drafted, and formed part of an extensively negotiated suite of documents, the Master felt neither able nor inclined to imply terms or interrogate why the parties reached the risk allocation that they did. If there had been a failure to think through the consequences of the drafting, that was not a reason to strain the construction of the ICD now to achieve what one party said they intended.

As a practice point, while the Master’s decision will not bind other courts (and in any event turns on the specific drafting of the bespoke permitted payments clause in issue in this case), the approach in this case is a reminder of the importance of tight contractual drafting. Intercreditor arrangements are often complex, and require detailed and careful consideration to ensure that they correctly document the parties' intentions during the life of the financing, and post default. While the permitted payments regime in this case was unusual, and typically intercreditor arrangements would expressly state that payments to parties other than senior lenders are only permitted before a default, it is important to carefully check bespoke provisions to ensure they interact with other provisions in the finance documents as intended (both before and after default).

We consider the decision in more detail below.

Background

Two lenders extended funds to a borrower for the development and sale of luxury flats. The senior debt had been refinanced while the junior debt remained in place; the arrangements between the creditors' claims against the borrower were documented in the ICD. The parties to the ICD were the borrower, the claimant junior lender, and the defendant security agent for the senior lenders.

The ICD generally prioritised the senior lenders' claims over those of the junior lender in terms of ranking and subordination. However, the ICD also contained an unusual permitted payments clause, providing that the junior lender would be entitled to receive 50% of the net proceeds from each flat sale until it had received a total of £1.5 million. The full text of clause 5 is set out at the foot of this blog post.

The borrower failed to pay interest on the senior loan when it was due, and the senior lenders also asserted that there was a breach of the loan to value covenant. The senior lenders accelerated the loan following this default and appointed a receiver. One of the flats (Flat 15) was sold shortly afterwards. The net sale proceeds were paid in full to the senior lender.

The junior lender commenced proceedings against the security agent for the senior lenders and applied for summary judgment on the interpretation of the ICD. The junior lender argued that it should have received 50% of the net proceeds from the sale of Flat 15 in accordance with the permitted payments clause, which it said continued to apply even after the appointment of the receiver. The security agent argued that the appointment of the receiver was an act of enforcement and therefore the permitted payments clause ceased to have effect; instead it argued that the entire net proceeds of any sale were required to be distributed in accordance with the general provisions relating to the application of proceeds of enforcement, which gave priority to the senior lender.

Decision

The High Court (Master Kaye) found in favour of the junior lender and allowed its summary judgment application.

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

Principles of contractual interpretation

The Master underlined that the question of whether the permitted payments clause continued to operate after the appointment of a receiver was a matter of contractual construction and referred to the established principles of contractual interpretation summarised in Wood v Capita [2017] UKSC 24 (see our blog post), in particular:

• The court's task is to ascertain the objective meaning of the language which the parties have chosen to express their agreement. Interpretation is a unitary exercise and the court must strike a balance between the rival interpretations and business common sense. In the present case, both parties relied on commercial common sense for their own interpretation of the ICD.
• However, the court must also be alive to the possibility that one side may have agreed to something which with hindsight did not serve its interest; and, where the parties have used unambiguous language, the court must apply it. Here, neither party had applied to rectify the ICD, nor was there any suggestion that a mistake had been made. In such circumstances, it was not the court's role to read into the ICD additional words or meaning simply because there may have been a failure to think through the consequences of the drafting in all scenarios.

Interpretation of the ICD

The Master made the following key observations:

• The ICD represented a negotiated position between all of the parties, including the borrower, in a situation where the senior funding was urgently required, as was the junior lender's agreement to subordinate its claims. The Master was not in a position to engage in a detailed analysis of why the parties might have negotiated the relative risk allocation as they did, and should therefore take the ICD as it stood.
• The ICD not only could work as the junior lender argued, but it made good commercial and business sense. It may or may not be quite what either party intended or thought they had negotiated but, having reflected on it and considered the disputed terms in context, it did work. If there had been a failure to think through the consequences of the drafting, that was not a reason to strain the construction of the ICD now to achieve what one party said they intended. That the ICD worked on its own terms weighed against any need to imply terms even if it were permissible to do so in a carefully negotiated document.
• The permitted payments clause provided some adjustment to the risk allocation between the senior/junior lender but not such as to suggest that it did not make commercial or business sense in the circumstances. It made sense and could operate in a logical and sensible way. It prioritised receipts to the junior lender of 50% of net sale proceeds only up to £1.5 million (a negotiated figure) when the total junior debt was around £4 million. This then left the junior lender to take their chances as subordinate to the senior lender for the balance due to them. If the senior lender had not recognised the consequences of the negotiated position in respect of the ICD, that did not mean that the clause did not mean what it says or that anything has gone wrong.
• The provision relating to the general application of proceeds (in satisfaction first of the senior debt, and then of the junior debt), was not expressly subject to the permitted payments clause (nor vice versa). The Master held that it was a general clause modified by the permitted payments clause, which made obvious commercial and business sense of the ICD. From a contextualised and textual analysis of the ICD, it was obvious and consistent with the structure the parties had agreed that the more precise, narrow and limiting specific provisions of the permitted payments clause took precedence over the broader application of proceeds provisions. This was the way in which the parties had operated the permitted payments clause until the receivers were appointed and, absent the appointment of the receivers, the way in which they accepted it would have continued to operate with the consent of the parties until the £1.5 million had been reached.
• The very fact that it seemed clear that enforcement was a real risk when the ICD was negotiated, formed part of the context in which the ICD needed to be considered. This was a further reason to suspect that it reflected a carefully negotiated compromise between the parties and meant what it said.
• The security agent's position on construction was "caused by a late or after-the-event realisation by the senior lender that in the absence of stop provisions… [the permitted payments clause] would continue after enforcement". The Master therefore considered this to be the type of case envisaged by Wood v Capita, in which one party had simply agreed something which with hindsight did not serve its interests.

Having regard to the above, the Master concluded that the permitted payments clause continued to apply after the appointment of the receiver. The Master said it was plain that the general application of proceeds provision operated subject to the permitted payments clause. Once the junior lender had received £1.5 million it would sit behind the senior lender until the senior lender was fully paid. The general application of proceeds provision would then be the only one which moderated how the proceeds of sale should be applied thereafter. Also, the Master was not persuaded that any of the arguments advanced by the security agent seeking to limit the permitted payments clause to pre-enforcement, fit with the natural meaning of the words used.

Accordingly, the Master found in favour of the junior lender and allowed its summary judgment application. The court also exercised its discretion to make a simple declaration that the permitted payments clause continued to apply after the appointment of the receiver.