On 13 July 2017 the High Court gave its judgment in UBS AG, London Branch v. GLAS Trust Corporation Limited [2017] EWHC 1788 (Comm), a case brought by UBS against the trustee for notes issued as part of a securitisation transaction by Fairhold Securitisation Limited (the “Issuer“). UBS disputed the ability of the trustee to absorb costs incurred by a group of noteholders pursuing a potential restructuring of the debt. The case will be of interest to trustees, investors and other stakeholders involved in the restructuring of finance transactions involving a trustee. The case provides some useful guidance on the test to be applied in determining whether expenses of a trustee have been “properly incurred“.
Background : The case involves a transaction from 2006 where notes were issued by the Issuer which intended to use the cash flows from a portfolio of 18,000 retirement and sheltered housing units to meet payment obligations under the notes. The claimant in this case, UBS, had entered into swap transactions with the Issuer to hedge the Issuer’s exposure to interest rates and inflation. The ingredients of the dispute have a familiar ring: the property assets have declined significantly in value over the last 10 years, and the remaining values will not be sufficient to discharge all of the Issuer’s outstanding liabilities under the notes and the swaps.
In March 2015, a group of noteholders formed themselves into an ad hoc group (the “AHG“) to consider possible restructuring scenarios. In October 2015, UBS exercised its right to terminate the swaps to which it was a party, and claimed a termination payment from the Issuer in excess of £300m. The termination payment was not paid. The Issuer subsequently failed to pay interest due on the notes, which was an event of default. At around the same time, GLAS Trust Corporation Limited was appointed as note trustee (the “Note Trustee“) in place of the incumbent trustee. An important contextual detail is that the Issuer has asserted that it is entitled to rescind the swaps (on the basis that the Issuer alleges that fraudulent misrepresentations had been made to induce the Issuer to enter into the swaps). The rescission issue remains outstanding, but the parties agreed to proceed with UBS’s claim on the basis that the swaps are valid.
On 31 March 2016, the Note Trustee was directed by an Extraordinary Resolution of the Noteholders to discharge certain fees, costs and expenses incurred by the AHG as “an expense of the Note Trustee” and on the basis that such expenses relate to work “which is for the benefit of the Noteholders as a whole“. The amount at that time was just under £2.5m, consisting of legal costs and financial advisory costs. The amounts have increased since. The priority of payments provides for payment first to the Note Trustee of its fees, costs and expenses, then to the swap counterparties (including to UBS) and then to the Noteholders. UBS disputed the Note Trustee’s right to adopt the AHG expenses.
The transaction documents contained relatively standard expenses clauses, under which the Issuer was obliged to pay expenses “properly incurred” by the Note Trustee in relation to (among other things) the exercise of the Note Trustee’s powers and authorities and the performance of its duties.
The Issues: One characteristic of the case was a late change of approach by the Note Trustee. It had originally contended that it was appropriate for the Note Trustee to adopt the AHG expenses as a matter of principle. This was on the basis that it considered that if the AHG had not obtained legal and financial advisory input, then the Note Trustee would have needed to obtain (and pay for) that advice in order to devise a strategy to maximise recoveries from the assets. The Note Trustee indicated that having made that assessment, it was not required to perform any audit of the actual costs to satisfy itself that the expenses came within the various categories set out in the expenses clause. Among other points, UBS argued that (i) the expenses had been “incurred” by the AHG and not by the Note Trustee; (ii) there was a lack of transparency as to what advice the Note Trustee had seen; (iii) it was not certain that the advice provided to the AHG did not cover possible litigation against the swap counterparties and (iv) the advice had been shared with the Note Trustee on a non-reliance basis. On this basis UBS argued that the AHG expenses were not expenses “properly incurred” by the Note Trustee.
Shortly before the hearing, the Note Trustee modified its approach and conceded that it would need to review the AHG expenses to assess whether the amount is excessive, and to satisfy itself that payment conforms to the Note Trustee’s powers under the documents.
The Judgment: Mr Justice Blair observed that the Note Trustee was right to modify its position, and that the adoption of the AHG expenses “required a degree of careful scrutiny by the Note Trustee in order to form the opinion that the expenses were properly incurred” and that its previous position “was not readily defensible“. In an important clarification for practitioners, the judge observed that it is possible for a trustee to adopt expenses incurred by third parties such as noteholders, thereby dispelling the technical argument that is sometimes made that a trustee must itself incur an expense for which it seeks reimbursement. The judge also accepted that trustee expense clauses are typically widely drafted, and stated that expense clauses:
“should be given a commercial and not artificially restricted meaning. This reflects the fact that the exercise of the trustee’s powers may contain a substantial measure of judgment, may be controversial and may have to be carried out speedily… the trustee should be able to fulfil its duties with confidence that if it acts in a commercially reasonable manner, it will be entitled to indemnification”
In the context of a draft order provided by the Note Trustee to reflect its modified position, the judge provided some preliminary guidance on expenses that would be proper. The judge concluded that, broadly speaking, a trustee was unlikely to be entitled to adopt expenses for advice on which it could not rely or which related to negotiations between creditors and not involving the trustee. However, he did not accept that these issues constituted bright lines or rules to be laid down by the court in the abstract and stated that it may indeed be appropriate, in particular cases, for a trustee to adopt the costs of advice even in such cases. The judge indicated (as a preliminary view) that advice relating to the manner and appropriateness of enforcement, valuation of assets and negotiating with parties in relation to these points would be a proper expense.
Conclusion: Trustees will be reassured that the courts recognise that widely drafted expense clauses are essential to the trustee’s role. They will also welcome the clarification that is provided around the meaning of “properly incurred“. Transaction parties sometimes argue for the less well defined (and perhaps more subjective) test of “reasonably incurred“, and trustees are likely to be more resistant to this formulation given the clarification this case provides around the scope of “properly incurred“. The case also reminds trustees that in exercising their powers, they need to be satisfied that they can stand behind the positions they have adopted against later scrutiny by other stakeholders and the courts.
