FML Timeline: BNY Mellon Corporate Trustee Services Ltd v LBG Capital No 1 Plc and another

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Lloyds Bank subsidiaries (LBG) issued £3.3bn of enhanced capital notes (ECNs) in 2009. The ECNs had specific maturity dates. However the trust deed constituting the ECNs provided for early redemption on the occurrence of a "Capital Disqualification Event" (CDE). Clause 19 of the trust deed provided that a CDE would occur if the ECNs "ceased to be taken into account" for the purposes of a regulatory capital requirements stress test. At the time the ECNs were issued LBG was subject to CRD I. Under CRD I the top tier of capital was Core Tier 1 (CT1). CRD I was succeeded by CRD II, III and IV. CRD IV defined a new (more restrictive) top tier of capital, Common Equity Tier I capital (CET1 Capital). It also defined a new category of capital- Additional Tier 1 Capital (AT1 Capital) which included contingently convertible loan stock such as ECNs.

The Prudential Regulatory Authority (PRA) carried out a stress test for LBG’s CET1 Capital in December 2014 and did not take the ECNs into account. LBG therefore announced that, under clause 19 of the trust deed, a CDE had occurred. BNY Mellon, the trustee of the ECNs, disagreed and issued proceedings on behalf of the ECN noteholders in order to prevent early redemption. The High Court held in favour of the trustee, concluding that a CDE had not occurred and that the trustee was not entitled to redeem the ECNs. The Court of Appeal disagreed allowing LBG's appeal. BNY Mellon appealed to the Supreme Court.

Decision

The majority of the Supreme Court agreed with the Court of Appeal’s conclusion that a CDE had occurred.

BNY Mellon advanced two arguments in support of its position that a CDE had not occurred. First that the stress test carried out by the PRA was in respect of Lloyds’ CET1 Capital rather than its Consolidated CT1 Capital as was explicitly referred to in the trust deed. Second BNY Mellon argued that under clause 19 of the trust deed it was not enough to show that the ECNs had not been taken into account for the purposes of the PRA’s stress test as a matter of fact, but instead the ECNs had to be disallowed in principle from being taken into account for the purposes of calculating LGB’s tier 1 capital before it could invoke the CDE definition. BNY Mellon argued that the ECNs could continue to be taken into account as part of the Tier 1 Capital if they were automatically converted into paid-up shares in LBG.

LBG's position was that as long as the ECNs could no longer assist LBG in passing the PRA’s stress test it could invoke the definition of a CDE.

Did the definition of CDE cover CET1 Capital?

The Court agreed with both the High Court and the Court of Appeal that the reference to Consolidated Core Tier 1 Capital in the CDE Definition should be interpreted as a reference to that type of capital or "its then regulatory equivalent" (i.e. Lloyds Common Equity Tier 1 Capital which was subject to the PRA’s stress test).

Had the ECNs “ceased to be taken into account”?

The majority of the Court agreed with LBG. In its view, the fact that the ECNs could not be taken into account for the very purposes for which their convertibility was designed (namely to enable them to be converted to meet LBG’s capital requirements) was sufficient for LBG to invoke the definition of CDE.

Noteworthy/ Novel points

The court demonstrated its willingness to deviate from the literal interpretation of a term in a high value contract (which was drafted by highly skilled legal teams) in order to give effect to the commercial purpose of the transaction to which the contract relates.

Where a document has been drafted with the intention of helping a party meet its regulatory obligations and of being responsive to regulatory change the Court will reflect those intentions in its construction of the document.