In May this year, we circulated an alerter on the English High Court decision Napier Park v Harbourmaster1 as to the proper construction of a ratings trigger in a CLO's reinvestment criteria. In particular, while we noted the relative clarity of the CLO's ratings trigger when compared to other provisions that we have seen, we concluded that the case demonstrates the need for particular care in drafting in this context. In an interesting reversal, the English Court of Appeal has overturned the judgment of the High Court.2
The original decision
The facts are set out in our original alerter. Put simply, the case centred on the meaning of the words "the ratings of the Class A1 Notes have not been downgraded below their Initial Ratings" in the reinvestment criteria and, in particular, whether the reinvestment criteria could ever be satisfied if the Class A1 Notes had been downgraded, even if the Class A1 Notes were subsequently upgraded to their Initial Ratings.
The High Court held that the words used were clear and unambiguous and that the phrase "have not been downgraded" indicates that something has happened at an unspecified time in the past. The High Court concluded that the intention of the parties was that the past occurrence of a downgrade could never be cured and that the reinvestment criteria could not subsequently be satisfied.
The decision on appeal
The High Court's decision was overturned on appeal. The reasons why the Court of Appeal thought that the original decision was wrong include:
- The phrase "have not been downgraded" can be interpreted in more than one way - it can mean "have not been downgraded at any time in the past" or "are not presently downgraded (even though they may have been in the past)".
- Following the decision of the Supreme Court in Re Sigma Finance Corp3, the Court of Appeal interpreted the CLO using an iterative process – testing each interpretation and investigating its commercial consequences, and the adoption of the interpretation which is most sensible.
- Having regard to the overall structure, construing the reinvestment criteria as being breached by virtue of an historic downgrade that was no longer continuing would raise the effect of that downgrade "to a level of pre-dominance which it was not designed to have". In particular, the court questioned why the parties would intend for there to be a breach of the reinvestment criteria as a result of an historic downgrade if that same historic downgrade had not breached alternative criteria that had previously been applied at the end of the earlier ramp-up period.4 Similarly, the court questioned why the senior noteholders would need protecting (by prohibiting reinvestment) if the notes were AAA-rated at the relevant time, which the court took to reflect an indication that the rating agencies were as sure as they could be that the senior noteholders' principal was not at risk.
While the implications of both the High Court judgment and the Court of Appeal decision will likely be limited to their facts (as they consider bespoke drafting), the most illuminating point is that the Court of Appeal reached a different conclusion in interpreting what the High Court considered to be a "clear and unambiguous" provision. It is yet another example of the English courts looking beyond the words on the page and exploring the commercial effect of the contract. It serves as another reminder that, while the words on the page might seem to be clear to those drafting a contract (and even might seem clear to a judge), the critical question is whether someone else might consider them to have an entirely different meaning. We said it before, and we'll say it again….drafters beware….
Contributors to the article include: Daniel Franks, Alex Campbell, Guy Usher, Edward Miller and Luke Whitmore.
1 Napier Park European Credit Opportunities Fund Ltd v Harbourmaster Pro – Rata CLO 2 BV  EWHC 1083 (Ch), High Court:
2 Napier Park European Credit Opportunities Fund Ltd v Harbourmaster Pro – Rata CLO 2 BV  EWCA Civ 984, Court of Appeal
3  UKSC 2
4 Because the investment criteria that applied at the end of the ramp-up period were drafted differently.