Corporate Debt Securities

Question 1

What is a Trust?

Answer 1

“A legal relationship created… by a settlor [whereby] assets are placed under the control of a trustee for the benefit of a beneficiary, or for a specified purpose.”

Thomson Reuters.

“Equity operates on the conscience of the owner.” Given that a trust is a creature of equity, this principle likewise applies.

Westdeutsche Landesbank Girozentrale v Islington LBC [1996] UKHL 12 at [705].

Question 2

What are the Elements of an Express Trust, i.e. the Three Certainties?

Answer 2

There must be Certainty of:

• Intention, i.e. willingness to create a trust.
• Object(s), i.e. the trust’s purpose and those who benefit from it.
• Subject Matter, i.e. what the trust pertains to.

Textbook, P. 376; Knight v Knight (1840) 3 Beav 148 at [173].

Question 3

How must Certainty of Intention be evinced in an Express Trust?

Answer 3

It must both written, forming a part of the Trust Deed, and apparent from the words used.

Textbook, P. 376; Re Kayford [1975] WLR 279 at [282].

Question 4

To Satisfy the Certainty of Objects, who must the Beneficiaries be?

Answer 4

Some legal or natural person who is clearly identifiable. They do not have to be named so long as, “they form an ascertainable class.”*

Textbook, P. 376; *IRC v Broadway Cottages [1955] Ch 20.

This is known as ‘The Beneficiary Principle’. Again, it demonstrates trusts’ favorability in the syndicated context because of how much it simplifies matters for the Borrower and Lenders, the latter of which’s membership can frequently change without the former’s knowledge. The former need only deal with the one trustee and reasonably assume that he speaks for all the Lenders, whoever or wherever they may be.

Textbook, P. 376.

Question 5

With respect to Tangible Property, what must be done to Satisfy the Certainty of Subject Matter?

Answer 5

The relevant assets must be specifically identified, meaning that a declared part of a defined pool of assets would not suffice because the specific assets the trust pertains to are unknown.

Textbook, P. 377; Wright v National Westminster Bank Plc. [2014] EWHC 3158 (Ch).

In the language of the Common Law, there must be an ‘ascertainable mass’.

Re London Wine Co. Ltd. [1986] PCC 121; Re Goldcorp Exchange Ltd. [1995] 1 Ac 74; Re Wait [1927] 1 Ch 606.

Question 6

With respect to Intangible Property, what must be done to Satisfy the Certainty of Subject Matter?

Answer 6

The relevant assets must still be identified, but on the basis of whether, “immediately after the purported declaration of trust, the court could, if asked, make an order for the execution of the purported trust.”

Textbook, P. 378-379; Hunter v Moss [1994] 1 WLR 934 at [945], which was followed in Re Harvard Securities Ltd. [1997] EWHC 371 and Re CA Pacific Finance Ltd. [2000] 1 BCLC 494.

From Hunter v Moss, it seems the reason for treating tangible and intangible assets differently is the indistinguishability of the latter from the former, e.g. company shares vis-à-vis wine bottles. Intangible pieces of property are inseparable, rather constituting a singular proprietary entity which ownership subsists in.

Textbook, P. 379-380; White v Shortall [2006] NSWSC 1379.

Question 7

In a Trust, who is the Legal Owner of the Assets?

Answer 7

The Trustee. He possesses the legal proprietary interest in the assets, whereas the beneficiares hold an equitable proprietary interest.

Textbook, P. 375.

This equitable proprietary interest subsists aginst any subsequent legal owners, with the exception of bona fide purchasers, even in in their insolvency.

Textbook, P. 375.

Question 8

Does a Beneficiary Rank higher than a Creditor in Insolvency?

Answer 8

Yes, but only with respect to the specific trust asset.

Textbook, P. 375.

This makes trusts particularly useful to Syndicates, given that there is no limit on the number of beneficiaries allowable.

Question 9

Is the Trustee a Fiduciary of the Beneficiary?

Answer 9

Yes. Both the elements of trust and confidence and the obligation of loyalty are present in the relationship.

Textbook, P. 375; Bristol and West Building Society v Mothew [1996] EWCA Civ 533 at [18].

Question 10

What are the Trustee’s Fiduciary Duties?

Answer 10

Aside from those explicated in the Trust Deed, it is under a general duty to:

• Act in the best interests of the Beneficiaries.*
• Perserve the Trust Fund.**
• Avoid conflicts of interest.***
• Avoid breaching its duty of care to the Beneficiaries.****

*Armitrage v Nurse [1998] Ch 241 at [253]; **Re Borgden (1888) 38 Ch D 546; *** Bray v Ford [1896] AC 44 and Boardman v Phipps [1967] 2 AC 46; **** Bartlett v Barclays Bank Trust Co. Ltd. (No. 2) [1980] 1 Ch 515.

Under Armitrage, with the exception of the fourth duty, these duties form the irreducible core of a Trust Deed, and are nonexcludable and unmodifiable. Regarding the fourth, while nonexcludable, it is modifiable with adjunctive clauses. Also, the duty of care and skill owed by a professional Trustee is higher than for a normal Trustee.*

*Bartlett v Barclays Bank Trust Co. Ltd. (No. 2) [1980] Ch 515 and Trutsee Act 2000 – §1 and Sch. 1.

Question 11

How is Certainty of Subject Matter determined in the Commercial Context?

Answer 11

By declaration of the Trustee that:

• He holds the trust property for the Beneficiaries in undivided shares as tenants in common; or
• the property is characterized as fractional interests in the whole in conjunction with a co-ownerhsip analysis.

Or by assessing whether the trust is capable of being administered and executed.

Textbook, P. 380-381.

Question 12

If the Trustee possesses and exercises the right to use the Trust Securities for its own purposes, is the Trust invalidated?

Answer 12

No, but only if it provides replacements of equivalent value.

Textbook, P. 381; Re Lehman Brothers International (Europe) (In Administration) [2010] EWHC 2914 at [73]-[76].

This is because a trust can be declared over property which the Trustee is to acquire ex post, i.e. after the declaration. What is ultimately most important is that the trust be declared over identifiable property.

Taliby v Official Receiver (1888) 13 App Cas 523.

Question 13

What happens when a Trustee mixes Trust Property with personal property?

Answer 13

Generally, “it remains trust property and can be traced, but only if it can be identified according to the rules of tracing.”

Textbook, P. 381; Foskett v McKeown [2001] 1 AC 103.

This is particulary important for intangible assets, e.g. cash or shares.

Question 14

How must a Transfer of Equitable Interest, i.e. change in Beneficiaries, be evidenced?

Answer 14

In writing.

Textbook, P. 381; Law of Property Act 1925 – §53(1)(c).

Question 15

What is a Corporate Debt Security?

Answer 15

A tradable debt instrument issued by a company to multiple Lenders.

Debt securities are issued on the primary market and traded on the secondary market. They vary enormously in nature.

Question 16

By what means are Debt Securities issued?

Answer 16

Through either a standalone issue or a programme.

Both are done on regulated exchanges and therefore attract regualtory supervision, particularly with respect to Offering Circulars. Short-term and medium-term securities are customarily issued under programmes, named Euro Commercial Paper (ECP) and Euro Medium-Term Note (EMTN) programmes, respectively.

Question 17

In terms of Documentation, how do Standalone Issuances and Programmes differ?

Answer 17

Standalone issuances require full documentation for each issue, whereas programmes operate on a single set of prelimiary documentation.

Programmes are more expensive to establish, but their documentary lightness makes up for their up-front cost in the long-run. As such, they are the favorable choice for issuers of vanilla securities who are operating on a long timeframe. Conversely, for the infrequenet issuer, the standalone route is likely cheaper in the long-run.

Question 18

Procedurally, how are Debt Securities issued?

Answer 18

Subject to its Mandate, the Arranger will:

• Advise the Issuer on whom to sell to in primary market and where to list the securities on the secondary market.
• Negotiate the securities’ terms with the Issuer, and will appoint a Trustee.

Upon Launch, the Issuer will:

• Enter into Subscription Agreements with Managers who will either invest or procure investors, liability under which is joint and several.

The Arranger, usually an investment bank, is an underwriter itself, and is usually joined by other banks, i.e. Managers, in the endeavor. Their duties will be outlined in an agreement between themselves. Joint and several liability for underwriting acts as a strong incentive on the banks to advise an accurate market price and find investors. Naturally, they are well-compensated for their risk.

Question 19

How is a Debt Security Issuance advertised to prospective investors?

Answer 19

Through an Offering Circular.

The debt security equivalent of a Prospectus, containing information about the Issuer and the Issuance.

Question 20

To what extent are Rating Agencies involved in the issuance of Debt Securities?

Answer 20

They rate both the Issuance and the Issuer.

An Issuer may thus attempt to tailor its Issuance’s terms according to its desired rating. Verily, it may even consult a Rating Agency on what a present incarnation of an Issuance would be rated and how that rating may be altered to achieve the desired result.

Question 21

What is the main advantages of listing an Issuance on an exchange?

Answer 21

Listing:

• Increases liquidity, and thereby, value.
• Sets a benchmark price for debt securities.
• Exempts the Issuer from having to withold tax at source when -paying interest, thus increasing profitability for investors.

Issuers will be wary of making securities available to the public due to the regulatory requirements that would incur. Rather, listed securities are typically limited to institutional investors. It is however critical to note that much of securities trading is done off the market, and that listing’s regulatory compliance is an expense and time-consuming.

Question 22

What is the Distinction between a Bond and a Loan Stock?

Answer 22

Both bonds and stocks are individual debt obligations, but the former is owed to each of the firm’s holders while the latter is single obligation that is either held by a trustee or created by a deed poll.

Loan stocks can be partitioned. Likewise, they are usually in registered form while bonds are usually in global bearer notes, but may take the form of registered global notes to comply with US tax regulation.

Question 23

Where are Debt Securities held?

Answer 23

Either in a Domestic or International Central Securities Depositary (DCSD) (ICSD).

The UK’s DCSD is CREST. The two major ICSDs are Euroclear and Clearstream.

Question 24

What are the Advantages of having a Debt Security held on Trust?

Answer 24

• Ease of settlement and transfer.
• Ease of cross-border investment through using local intermediaries.
• Facilitation of security-backed transactions, e.g. secured loans.
• Value-adding services provided by the intermediary, e.g. management or financial servcies.

Question 25

For Bondholders, what Advantages does a Trustee bring?

Answer 25

• Representaiton by an expert for the Bondholders.
• Circumvention of CAPs for Bondholders, e.g. better monitoring, swifter enforcement action taken, which increases efficiency.
• Greater bargaining power for Bondholders.
• Perserves anonymity for Bondholders.
• Facilitaiton of negotiations with the Issuer, e.g. exchange of confidential information or inclusion of sophisticated covenants.

In effect, by collectivizing Bondholders’ interests and concentrating them into the hands of an expert entity bound by fiduciary duties, the Trustee Structure neutralizes CAPs and the problem of dispersed ownership to the ultimate benefit of Bondholders. Of course, this comes at an expense and a sacrifice of control.

Question 26

For Issuers, what Advantages does a Trustee bring?

Answer 26

• Convenience of sophisticated single-party negotiation.
• Sanctuary from the Mad Bondholder problem and multiplicity of actions,* namely through the Trustee’s No-Action clause​,

*Elektrim SA v Vivendi Holdings 1 Corp. [2008] EWCA Civ 1178.

The Mad Bondholder problem is the fear of an acceleration by a single Bondholder because of a minor EOD. Akin to it is the Hold Out problem,* where a minority of Bondholders attempt to take action which harms the collective’s or Issuer’s interests. The No-Action clause provides that no Bondholder can take enforcement action unless the majority has instructed the Trustee to do so.

*Re Colt Telecom Group Plc. [2002] EWHC 2815 and Elektrim.

Question 27

For Secured Parties, e.g. in a Loan, what Advantages does a Trustee bring?

Answer 27

• Elimination of the need to create new security interests upon transfer, thus sparing time and money and increasing liquidity.
• Enabling of collective enforcement of security.
• Standardization of terms for Creditors.
• More efficient administration of subordination.

In effect, the intermediary role a Security Trustee facilitates transferability, and thus liquidity, while maintaining the risk parameters that would have obtained otherwise.

Question 28

Regarding Stocks held on Trust, to what extent do Stockholders have rights against the Issuer?

Answer 28

Because stockholders are not directly owed principal or interest, they are not creditors. Also, because they are beneficiaries, legal title in the debt does not vest in them, but rather in the Trustee.

Stockholders are possessors of equitable interest. Notably, the Trustee holds the benefit of the stock on the stockholders’ behalf. Therefore, it is the entity intermediates finances payment the Issuer and Stockholders. It will also hold any present security on their behalf. Stockholders cannot enforce anything directly, but they can compel the Trustee to do so on their behalf. Finally, ‘directly’ is a reference to there existing a covenant, i.e. loan agreement.

Question 29

What is the Difference Between a Fiscal Agent and a Bond Trustee?

Answer 29

A Fiscal Agent acts on behalf of the Issuer whereas a Bond Trustee acts on behalf of the Bondholders, to whom it owes fiduciary duties.

Debt securities are hereafter referred to as ‘Bonds’ unless otherwise specified, and their holders are hereafter referred to as ‘Bondholders’ unless otherwise specified.

Question 30

What is the Main Function of the Fiscal Agent?

Answer 30

To act as the Issuer’s representative and agent.

This includes paying Bondholders most importantly, amonst other things like minorly modifying a Bond’s terms.

Question 31

What are the Main Functions of the Bond Trustee?

Answer 31

• To see to modifications to the terms of Bond Deed or securities;
• To receive information from the Issuer and monitor the its compliance with its payment obligation; and
• To act on possible EODs.

The Trustee’s powers and obligations originate from the Trust Deed, which is negotiated with and executed by the Issuer. This is a process that the original Bondholders are not necessarily party to.

Question 32

Can the Bond Trustee unilaterally agree to a Modification, and if so, for what reasons?

Answer 32

Yes, but only if it beileves it will not materially prejudice Bondholders’ interests, will correct an error, or is minor or technical in nature.

Question 33

What is the Nature of the Bond Trustee’s Monitoring Function?

Answer 33

As it is under no duty to seek out EODs and may assume that none exist, absent actual notice, it mostly relies on compliance certificates from the Issuer’s Board.

All of this is laid out in the Trust Deed, and as it stands, the Bond Trustee’s monitoring capacity is very limited. For Bondholders, this is problematic as neither they nor the Trustee will receive any advance warning of a default.

Question 34

When will an Event of Default constitute a Breach?

Answer 34

When it is materially prejudicial to Bondholders’ interest in light of its consequences.

Law Debenture Trust Corporation Plc. v Acciona SA [2004] EWHC 270 [42-48].

If it is not, the Trustee will waive it. If it is, the Trustee will certify it as so and a decision will have to be taken regarding whether to waive it or act upon it. Acceleration is not the only option available, as the Issuer could simply be liable for damages. Also, the Bond Deed may specifiy that certain EODs, e.g. nonpayment, are automatic breaches.

Question 35

Must the Bond Trustee exercise its discretion to act on an Event of Default?

Answer 35

No, but it must properly consider the exercise of the power and have reason for not using it.

Re Manisty’s Settlement [1974] Ch 17.

Typically, the Bond Trustee will require indemnification to its satisfaction from Account Holders, before it acts on an EOD, as risk collateral or for funding expert advice. The Trust Deed will typically expressly provide for indemnification, especially given that the Trustee need not go out of pocket to accord with its obligation.*

*Concord Trust v Law Debenture Trust Corporation Plc. [2004] EWHC 1216 at [33].

Question 36

What constitutes Satisfactory Indemnification for a Bond Trustee to act on an EOD?

Answer 36

Indemnification which may reasonably sufficiently cover the Trustee’s expense and hedge against its the potential liability for ultra vires enforcement or other legal exposures.

• Concord Trust v Law Debenture Trust Corporation Plc.* [2004] EWHC 1216 at [33-34].
• Wednesbury* Reasonableness is the material standard here, i.e. would any reasonable Trustee have been satisfied by the relevant sum. The amount of potential liability will be assessed with reference to the worst-case scenario, but the risks themselves must be, “more than fanciful.”

Question 37

Does Wrongful Acceleration give the Issuer a valid of Cause of Action against the Bond Trustee?

Answer 37

No. Acceleration by the Trustee has no contractual effect,* and cannot give rise to tortous damages because no duty of care exists.**

*Concord Trust v Law Debenture Trust Corporation Plc. [2004] EWHC 1216; Bournemouth v Lloyds TSB Bank Plc. [2003] EWCA Civ 1755; BNP Paribas v Yukos Oil Company [2005] EWHC 1321; ** Concord Trust at [38-43]

Despite its legal weightlessness, the mere service of notice may trigger cross-default clauses in other facilities. Likewise, acceleration can deleteriously affect the Issuer’s reputation, and thus its economic well-being, if the information becomes public.

Question 38

What is the Subject Matter of a the Bond Trustee’s Trust?

Answer 38

Its covenant with the Issuer.

The covenant contains, amongst other things, its right to payment and enforcement.

Question 39

What is the Classic Global Note (CGN) Structure?

Answer 39

A deposit structure where securities, whether bearer or registered, are deposited with a Depositary on behalf of the ICSDs. The Depositary also provides services for such seurities.

The Depositary is typically a commercial bank, and can be situated anywhere. The services it provides are safekeeping and asset servicing, e.g. paying Bondholders or exchanging the Bond. It is the Issuer who deposits the security with the Depositary. The ultimate Bondholders hold accounts with the ICSDs, the platform upon which transactions are made.

Question 40

What is the New Global Note (NGN) Structure?

Answer 40

A deposit structure where securities, only in bearer form, are deposited with a Common Safekeeper (CSK) and serviced by a Common Service Provider (CSP), both of which are usually an ICSD.

The effect, therefore, is to cut out Depositaries altogether. NGN uses the ICSDs’ records to determine the outstanding amount on an issue, as opposed to CGN which uses the physical annotations on the global note itself. Further, NGN only applies to securities issued through the ICSDs, i.e. for which they are the place of primary deposit. Therefore, securities issued through CSDs fall under CGN.

Question 41

Who do ICSDs hold Bonds for?

Answer 41

Account Holders.

Account Holders are usually banks, holding the security either for themselves or as an intermediary for the ultimate Bondholders.

Question 42

Assuming CGN, what is the Chain of Holding with respect to a Bond?

Answer 42

Issuer → Depositary → ICSD → Account Holder → Dealer → Bondholder.

A Dealer is bank or broker. Assuming NGN would lead one to the same structure, just without the Depositary.

Question 43

Under CGN and NGN, from where do Bondholders derive their rights?

Answer 43

From an entry in the books of either an ICSD or an intermediary.

This is due to the Bonds’ dematerialized form.

Question 44

Assuming CGN, what are the possible Legal Relationships between the Depositary and the ICSD?

Answer 44

A Bond is held by the Depositary on behalf of the ICSD either on trust or as bailee, the latter entailing that ICSD holds the Bond on trust for the investors.

Trusteeship is the perferred analysis. Bonds in an ICSD are meant to remain within it, but payment must nonetheless flow to the Bondholders. Therefore, it is preferable to vest legal ownership in ‘holder’, i.e. the Depositary, who is entitled to payment and must disburse it rateably and accordingly to the ultimate Bondholders. Verily, this often explicity provided for in the Issuance’s documentation, namely that the Depositary is the Bond’s owner.

Question 45

Assuming NGN, given that the Depositary is absent, what is the ICSD’s legal position?

Answer 45

As legal owner, it holds the Bond on trust for its relevant Account Holders. This is because of:

• Its direct contractual relationship with the Issuer;
• The legally-relevant record of indebtedness it maintains; and
• Its functions as CSK and CSP.

Even if other parties functioned as CSK and CSP, it would make more sense to construe them as bailees given the other factors. The above will be taken as the default NGN analysis henceforth.

Question 46

Assuming NGN, considering that ICSDs hold Bonds on Trust for their Account Holders, and assuming that said Account Holders are Intermediaries, how do Ultimate Bondholders recieve the benefit of their investment?

Answer 46

Account Holders’ beneficial interest in the Bond is held on trust for the ultimate Bondholders.

This is known as a Sub-Trust, and there can be several layers of them. Critically, an immediate sub-beneficiary only has rights against its immediate sub-trustee.* This so-called ‘No-Look-Through’ principle is often expressly provided for in documentation, and may protect Issuers from liability in case of Trustee nonperformance.** Kindred is the ‘No Upper-Tier Attachment’ principle, which states that Creditors’ claims rest at the specific intermediary’s tier in the hierarchy.

*Hayim v Citibank NA [1987] AC 730; **Secure Capital SA v Credit Suisse AG [2017] EWCA Civ 1486 and Eckerle v Wickeder Westfalenstahl GmbH [2013] 68 (Ch).

Question 47

Assuming CGN or NGN, Where is the Bondholders’ right to enforce against the Issuer vested?

Answer 47

The Bond Trustee holds its right to enforcement on trust for the Bond’s legal owner, usually an ICSD, who may then be directed to act accordingly by the Bondholders.

It will be recalled that this right to enforcement originates from the covenant between the Trustee and the Issuer.

Question 48

Assuming a Trust Structure or a Fiscal Agent Structure, how can a Bondholder’s interest in a Bond be described?

Answer 48

As an ultimate beneficial co-ownership interest in a contractual interest against the Issuer, which is held by the Bond’s legal owner.

The Bondholder is co-owners with his peers, whether through a trust or a sub-trust. He is therefore incapable of claiming directly against the Issuer for the contractual interest, rather having to sue up the chain. However, this may prove problematic if an intermediary has excluded its obligation to take any such action. Finally, consequent to the ultiamte interest being against the Issuer, the Bondholder is exposed to its credit risk.

Question 49

Assuming CGN and NGN, if an Intermediary has excluded its obligation to sue, how can the Bondholders enforce?

Answer 49

The Deed between the Bond Trustee and the ICSD may provide that:

• The Bond Trustee must foremost consider the interests of the Account Holders, rather than the ICSD; or
• The Account Holders are on equal footing with the ICSD with respect to instructing the Bond Trustee, i.e. a ‘Look-Through’ provision.

The first option is problematic if the Account Holders are intermediaries who neither want nor must sue the Issuer. Regarding the second, the ICSD could alternatively set up a system to ascertain instructions from Account Holders and pass them on to the Bond Trustee.

Question 50

Assuming a Fiscal Agent Structure, how do the Bondholders safeguard their right to enforce?

Answer 50

By having the Issuer execute a Deed Poll at issuance, thus imposing upon it a direct obligation to pay the bondholders if a default occurs.

This mechansim may provide little recourse in practice if the Issuer is near-insolvent or insolvent when it defaults. Alternatively then, the Contract (Rights of Third Parties) Act 1999 may be used to enable Bondholders, as a class, to enjoy the benefit of the obligation owed to the legal owner, i.e. ICSD or Depositary. The Bondholders may also call for the issue of a definitive security, which effectively provides collateral for their risk exposure.

Question 51

What is the Decision-Making Process with respect to a proposed action relating to the Bond, e.g. alteration or acceleration?

Answer 51

Typically, a Bondholders’ Meeting will be called to decide the action by way of a vote, in which quorum and majority requirements will be set.

This procedure will typically be set out in the Bond’s Deed or the Trust Deed. All Bondholders are entitled to either attend the Meeting or send a proxy on their behalf, and will be given notice ahead of time. More serious actions, e.g. the alteration of entrenched terms, may have to satisfy a higher majority threshold of up to 75%.

Question 52

How are Bondholders given notice of a Bondholders’ Meeting?

Answer 52

Assuming a Bond is held through a clearing system, notice will be given through the system itself.

In light of the tradability of Bonds, to ensure that the correct parties are those entitled to vote, the relevant Account Holder will have to ‘block’ its account. Naturally, for this strategy to be effective, it must be carried out throughout the entire chain of holding.

Question 53

In a Bondholders’ Meeting, is there a Good Faith obligation attaching to the right to vote?

Answer 53

Yes. The majority must act in good faith* and in the collective best interests of the class**.

*Goodfellow v Nelson Line (Liverpool) Ltd. [1912] 2 Ch 324; **British America Nickel Corporation Ltd. v MJ O’Brien [1927] AC 369.

Having said that, each Bondholder is entitled to vote in its own best interests.* As such, the obligation appears to be proscriptive rather than prescriptive.

*Goodfellow v Nelson Line (Liverpool) Ltd. [1912] 2 Ch 324.

Question 54

Must the ability of the Majority to Bind the Minority be expressly qualified by contract?

Answer 54

Yes.

Assénagon Asset Management SA v Irish Bank Resolution Corporation Ltd. [2012] EWHC 2090 (Ch).

Question 55

If a Bond’s Deed establishes different Classes of Bondholder, must each Class vote in the interests of the Collective as a whole?

Answer 55

No. Each class is entitled to vote in its own interests so long as it is acting in good faith.

Redwood Master Fund Ltd. v TD Bank Europe [2002] EWHC 2703.

Again, this reflects the proscriptive, as opposed to prescriptive, nature of the Good Faith obligation.

Question 56

Barring a Bondholders’ Meeting, how else are the views of Bondholders ascertained?

Answer 56

Through Trustees’ informal consultation with Bondholder Committees or Bondholders themeslves.

A Bondholder Committee is an association representing the collective interests of a particular group of Bondholders. Their existence is made possible by the fact that most Bondholders are repeat-playing institutional investors.

Question 57

At a Bondholders’ Meeting, can the Issuer offer the Bondholders a monetary incentive to vote for a particular outcome?

Answer 57

Yes, but only if the offer is fully disclosed and available to every Bondholder.

Azevedo v IMCOPA [2013] EWCA Civ 364.

Question 58

At a Bondholders’ Meeting, is the use of an Exit Consent strategy an abuse of power?

Answer 58

Not necessarily. If Bondholders are given ample time to consider their options and observe how their peers will vote, it will not constitute an abuse of power.

Assénagon Asset Management SA v Irish Bank Resolution Corporation Ltd. [2012] EWHC 2090 (Ch).

An Exit Consent strategy is one where the Issuer asks the Bondholders to consent to an exchange of their existing bonds for new ones on different terms, rendering the original bonds much less valuable or worthless. Because of the coordination problems in Bondholder decision-making, this creates a Prisoner’s Dilemma, hence why ample time and observation of voting is necessary to curb absue of power.

Question 59

Regarding the Restructuring of a Bond, barring a Bondholders’ Meeting, how else can the Majority Bind the Minority?

Answer 59

Through either a Scheme of Arrangement* or a Company Voluntary Arrangement**, wherein a majority of creditors in both numbers (50%) and value (75%) can sanction the restructuring.

*Companies Act 2006 – §895; **Insolvency Act 1986 – Part I.

The problem with these strategies is that, technically, only the Trustee and Legal Owner are creditors. It is therefore appears impossible to acquire the requisite majority in numbers. However, the solution is to characterize ultimate Bondholders as ‘contingent creditors’ on the basis of their right to receive definitive notes.

Re Castle Holdco 4 Ltd. [2009] EWHC 1347.

Question 60

Can a Bond Trustee exclude liability for Breach of Fiduciary Duties?

Answer 60

Yes, with the exception of the equitable duty to exercise reasonable care and skill; any clause in a Trust Deed exempting liability for its breach will be void.*

Companies Act 2006 – §750(1).

Having said that, §750(1) is limited to blatant exclusion clauses, and does not catch provisions that allow the Trustee to rely on specialist advice or confer its discretion, acts which would otherwise be in breach of trust. How the Trustee’s obligations are imposed and defined, and how liability attaches to them, is stated in the Trust Deed. Verily, liability for any form of negligence can be excluded therefrom, but the line between negligence and good faith can be hard to draw.*

Spread Trustee Co. Ltd. v Hutcheson and Others [2011] UKPC 13 at [61]

Question 61

In the Commercial Context, how will the provisions of a Bond or Trust Deed be construed?

Answer 61

For the most part, as though the Deed were a contract, with reference to the same principles and precedents.

Concord Trust v Law Debenture Trust Corporation Plc. [2005] UKHL 27 at [37]; Armitrage v Nurse [1998] Ch 241.

Naturally, it should be kept in mind that a Trust and a Contract are two different legal tools, and that therefore, the transplantation of the principles and precedents of law and equity should be approached with some caution. For example, §2(2) UCTA 1977 does not apply to Trust Deeds. Context is also critical. Commercially, Armitrage’s irreducible core duties are likely to be interpreted very narrowly.*

*Citibank NA v MBIA Assurance SA [2006] EWHC 3215.

Question 62

Why would a Lender enter into Bond as opposed to a Loan?

Answer 62

Bonds are lower risk assets compared to Loans.

Naturally, this also means they are less profitable.

Question 63

Why would a Borrower issue a Bond as opposed to take out a Loan?

Answer 63

• The interest rate payable for Bonds is typically lower than for Loans;
• The covenants are much less restrictive; and
• The Bond is a much more flexible tool than the Loan.

As such, Bonds may be the optimal financing choice from the standpoint of both cost-savings and operational freedom. Critically however, this option is really only availble to large firms due to their wide choice of credit providers and strong credit ratings. Smaller firms, who may not be as well-endowed, will also typically have much smaller financing needs and will thus have to pay disproportionately high insurance costs for issuances. Also, the cov-lite trends is underscored by a serach for higher yields on Investors’ part.

Question 64

What is the Economic Function of the Credit Rating Agency (CRA)?

Answer 64

To ameliorate information asymmetries between Lenders and Borrowers.

Ratings can affect both the availability of credit to a Borrower and the lending practices of a Lender, given that it will have to comply with capital adequacy requirements.

Question 65

What are the Core Features of a Bond?

Answer 65

• Par Value.
• Interest Rate (fixed/floating).
• Maturity.

All of these features can be freely added to or varied, so as to most effectively meet the Issuer’s and prospective Bondholders preferences and market conditions.

Question 66

What is a Deep Discount Bond?

Answer 66

A zero-coupon Bond that allows the Bondholder to aquire the debt security at a significant discount to its par value, thus generating a profit at maturity.

Zero-Coupon = non-interest-paying.

Question 67

What is a Step-Up Bond?

Answer 67

A Bond which increases its coupon after an initial period.

Question 68

Is Interest always payable regardless of the Issuer’s profitability?

Answer 68

For traditional Bonds, yes. However, for certain hybrid securities, interest may be payable at maturity.

This is known as Payment in Kind (PIK) Interest.

Question 69

How long are Bonds’ Maturity?

Answer 69

It ranges from one year to decades. Verily, some hybrid securities may be indefinite.

Having said that, Bonds may include put options which that enable Bondholders to force redemption under certain circumstances, e.g. restructuring or takeover that triggers a ratings downgrade.

Question 70

What is a Conversion Clause in a Bond?

Answer 70

One which entitles Bondholders to forcefully convert their debt securities into a fixed number of equity securities, namely those of either Issuer or a member of its Group.

The Conversion Price is struck at the time of issue, and is typically at a significant premium (25%-30%) of the equities’ market price. Likewise, the coupon for Convertible Bonds tends to be substandard. Exercise of this right release the Issuer’s debt obligation to the Bondholders. Similar instruments are the Bond with a Warrant, which is just a Bond with a tradable entitle to subscribe for shares, and the Exchangeable Bond, which is Convertible Bond that may convert into the equities of a firm outside the Issuer’s Group.

Question 71

Why do Anti-Dilution Covenants form a part of the Bond Deed for Convertible Bonds?

Answer 71

To mitigate voluntary action by the Issuer that could decrease the value of the equity into which the bonds convert.

Such actions include returns of capital, discounted dispoals of assets, new share issuances, capital reorganizations, etc.

Question 72

According to Elektrim, what is the practical reach of the No-Action Clause?

Answer 72

It applies to claims that both in terms seek to enforce the Deed and those which in substance seek to do the same.

Elektrim SA v Vivendi Holdings 1 Corp. [2008] EWCA Civ 1178.

Therefore, the clause should be construed, to the extent reasonably possible, as an effective bar to individual bondholders pursuing, for their own account, what were in substance class claims, whether in contract or tort.

Question 73

Why are most Bonds traded OTC, i.e. off-the-market?

Answer 73

• Debt markets are significantly larger than equity markets, and therefore less concentrated.
• Nominally, Bonds tend to be signficinatly larger the equities.
• Bond trading is very infrequent relative to equity trading.

As such, considering the bredth of the debt market, the size of the Bonds traded therein, and the relative lack of constantly available buyers and sellers for said Bonds, it is seemingly natural conclusion that most trading is done off of listing venues.