Ready to pull the (Downgrade) trigger?
The English High Court recently had to consider the contractual construction of a ratings trigger. While the case (Napier Park European Credit Opportunities Fund Limited ("Napier") v Harbourmaster Pro-Rata CLO 2 B.V. and others ("Harbourmaster")) considered the reinvestment criteria of a CLO, the issues will be just as important for ratings triggers, events of default, termination events and other provisions in ISDA Master Agreements, securitisations and other documentation. In our experience, insufficient attention is often given to the drafting of such provisions, and ambiguities are a real issue when one of the parties tries to rely on them.
The reinvestment criteria in the CLO included a requirement that "the ratings of the Class A1 Notes have not been downgraded below their Initial Ratings". The Class A1 Notes were downgraded below their Initial Ratings in February 2010 and then subsequently (in November 2012, some two and a half years later) upgraded back to their Initial Ratings. The issue that the court had to consider was whether the fact that the Class A1 Notes had been downgraded below their Initial Ratings meant that the reinvestment criteria could never be satisfied, or alternatively whether the reinvestment criteria were capable of subsequently being satisfied if and when the Class A1 Notes were upgraded back to their Initial Ratings.
Napier, which was a junior noteholder in the CLO, claimed that the reinvestment criteria were satisfied once the Class A1 Notes had been upgraded back to their Initial Ratings. The senior noteholders claimed that the reinvestment criteria could never be satisfied once the Class A1 Notes had been downgraded below their Initial Ratings, even if they were subsequently upgraded.
The court found in favour of the senior noteholders. It concluded that the effect of the language in question was that, once the Class A1 Notes had been downgraded below their Initial Ratings, the reinvestment criteria could never subsequently be satisfied, even if the Class A1 Notes were upgraded back to their Initial Ratings.
The court applied the following analysis and found that, in its context, the wording was clear and unambiguous:
The words used ("have not been downgraded") are the present perfect tense, indicating that something has happened at an unspecified time in the past.
The use of other tenses in the documentation supports that analysis, such as other reinvestment criteria requiring that no Event of Default has occurred "which is continuing".
Other provisions in the documentation referring to the Initial Ratings also uses alternative language indicating a different tense, such as "the Initial Ratings of the Notes being downgraded".
Given the inherent nature of the issue, any case relating to contractual construction is, strictly, limited to the contract in question. However, the case emphasises an important drafting lesson – that it is important to use particular sensitivity in drafting these provisions, and in particular to use consistent terminology throughout the contract. The ratings trigger considered by the court was, in our experience, relatively clear compared to others we have frequently advised on. Drafters be warned…