Napier Park European Credit Opportunities Fund Ltd v Harbourmaster Pro-Rata Clo 2 B.V. & Ors

On 23 August 2006 Harbourmaster Pro-Rata CLO 2 B.V. ("the Issuer") raised €602 million through the issues of 14 classes of notes ("the Notes"). The Notes are secured on the proceeds of an underlying portfolio of loans originally owned by the Issuer under what is known as a collateralised loan obligation (“CLO”) structure. The different classes of Notes had different priorities for redemption, and each class carried a different rate of interest. The dispute arises between the Senior Noteholders, who hold Class A1 Notes ("the Senior Notes"), and the Junior Noteholders, who hold Class C Notes. The question is whether a substantial sum of money representing Unscheduled Principal Proceeds ("UPP") is available to be reinvested or should be paid out to noteholders. The UPP are only available to be reinvested if they meet “Reinvestment Criteria” specified in the documentation. Whether they do turns on the question whether the provision that "the ratings of the Class A1 Notes have not been downgraded below their Initial Ratings" is unsatisfied because the Senior Notes were downgraded on 5 February 2010 by Standard & Poor's Rating Group ("S&P") from their Initial Rating of AAA to a rating of AA, even though they were then upgraded back to an AAA rating by S&P on 30 November 2012.

The Junior Noteholders contend that the UPP are available for reinvestment. The Senior Noteholders contend to the contrary. The Chancellor of the High Court decided the question in favour of the Senior Noteholders. Napier Park, one of the Junior Noteholders, represented by Mr Robert Miles QC and Mr Gregory Denton-Cox, now appeals. When I read the papers in preparation for the hearing I provisionally took the view that the Chancellor was correct. However, Mr Miles’ excellent oral advocacy has persuaded me that he was wrong. Accordingly, for the reasons that follow I would allow the appeal.

The overall terms of the transaction are contained in a suite of interlocking documents entered into on 23 August 2006. It is common ground that these documents must be read in conjunction with each other. The three main documents were a Trust Deed constituting the Notes, a Collateral Management Agreement between the Issuer, the Collateral Manager and the Trustee (“the CMA”) and a Collateral Administration Agreement between, amongst others, the Issuer, the Collateral Administrator, the Collateral Manager and the Trustee (“the CAA”).

The Chancellor described the overall form of the transaction in terms which for the most part I gratefully adopt. The 14 classes of Notes issued on 23 August 2006 are divided into two sets of Senior Notes, seven sets of mezzanine Notes and 5 sets of subordinated junior Notes ("the Junior Notes"). They have a maturity date of 2022 but the offering circular makes clear that it is anticipated that they will be repaid or redeemed before then. Under the waterfall provisions of the CLO each of the classes of Notes is subordinated to the payments of principal and interest on the class of Note above them in the structure. At the time of their issue the Senior Notes were rated AAA by Fitch Ratings Ltd and Standard & Poor’s (“S&P”). That rating was a condition of the issue and sale of the Notes. This was their "Initial Rating" as defined in the CLO documentation.

The sums raised by the issue of the Notes together with sums advanced by one class of Senior Noteholders were applied (after payment of fees and expenses) in the purchase of a portfolio of loans and participations in loans ("the Portfolio") described in the CLO documentation as "Collateral Obligations". These were defined as follows:

““Collateral Obligation” (a) any Loan which satisfies the Eligibility Criteria or, as the case may be, the Reinvestment Criteria at the time of acquisition; and (b) any sub-participation in Underlying Loans from time to time entered into with Qualifying Institutions pursuant to the terms of a Direct Sub-Participation Agreement, which satisfies the Eligibility Criteria or, as the case may be, the Reinvestment Criteria at the time of acquisition.”

Proceeds arise under the Portfolio from three principal sources: payment of interest on the Collateral Obligations, sale of the Collateral Obligations, and repayment of the Collateral Obligations by the borrower. Interest is not available for reinvestment but is used on the next Payment Date after receipt to pay certain items in the Priorities of Payment waterfall. If Collateral Obligations are sold, the proceeds of sale are treated as principal. The monies generated by such sales are defined as Sales Proceeds and must be paid by the Collateral Administrator into the Principal Account. They are then used to redeem the Notes in accordance with the waterfall. If a borrower repays a Collateral Obligation, the repayments may either be Scheduled Principal Proceeds or UPP. They will be Scheduled Principal Proceeds if they are repaid in accordance with the terms of the underlying Collateral Obligation. They will be UPP if they are repaid early, that is to say before the maturity of the underlying Collateral Obligation. These proceeds are also "Principal Proceeds" as defined in the CLO documentation, but result from the action of the borrower, rather than the Collateral Manager.

The lifecycle of the CLO divides into several relevant periods. The Ramp-Up Period began on the Closing Date of the transaction (23 August 2006) and ended on the Effective Date (23 May 2007). During that period the Collateral Manager was required to use all commercially reasonable efforts to ensure that the proceeds of the issue of the Notes were applied in the acquisition of Collateral Obligations which satisfied the Eligibility Criteria and Reinvestment Criteria. The Notes cater for the possibility that at or after the Effective Date the Notes are downgraded from their initial ratings. The definition of “Effective Date Rating Event” provides, so far as material, as follows:

“Effective Date Rating Event means

(a)

… (ii) the Initial Ratings of any of the Notes being downgraded or withdrawn, or (iii) any of the Ratings Agencies notifying the Collateral Manager … that such Ratings Agency intends to reduce or withdraw any of its Initial Ratings of the Notes, in the case of (ii) or (iii), upon request for confirmation of the Initial Ratings by the Collateral Manager… following the Effective Date; and

(b)

either the failure of the Collateral Manager … to present to the Rating Agencies or the failure by any Rating Agency to accept a Rating Confirmation Plan setting out the actions the Collateral Manager … is intending to take in order to cause the Initial Ratings to be confirmed or reinstated…”

It is important to note that an Effective Date Rating Event will not occur unless both (a) and (b) are satisfied. The obligation on the part of the Collateral Manager to seek the confirmation referred to in that definition arises under clause 10.4 of the CMA. However, that clause (and condition 7 (d) of the Notes itself) also makes clear that the Collateral Manager has no obligation to present a Rating Confirmation Plan. The consequence of an Effective Date Rating Event is dealt with by condition 7 (d) of the Notes which provides, so far as material:

“In the event that, as at the second Business Day prior to the Payment Date following the Effective Date … an Effective Date Rating Event has occurred and is continuing, the Notes shall be redeemed in accordance with [the waterfall] until redeemed in full or, if earlier, until the Rating Agencies confirm the Initial Ratings of the Notes.”

The next relevant period of the CLO lifecyle was the Reinvestment Period. That began on the Closing Date (23 August 2006) and ended on 15 October 2013.

The third relevant period began on 15 October 2013 and will end on 15 October 2015.

Clause 11 of the CMA provides for the sale and, in certain circumstances, reinvestment by the Collateral Manager of certain types of Collateral Obligation. Clause 11.1 deals with the sale of "Credit Impaired Collateral Obligations"; clause 11.2 with the sale of "Defaulted Collateral Obligations"; clause 11.3 with the sale of "Appreciated Collateral Obligations"; and clause 11.4 with the discretionary sale of Collateral Obligations. The basic principle is that sale proceeds from such sales are to be reinvested during the Reinvestment Period. But in each case a pre-condition of reinvestment is that "no Event of Default [has] occurred which is continuing". "Events of Default" are matters such as non-payment of interest or principal and the occurrence of certain insolvency events. Clause 11.6 provides that during the Reinvestment Period the Collateral Manager shall use all commercially reasonable efforts to apply Scheduled Principal Proceeds in the acquisition of further Collateral Obligations satisfying the Reinvestment Criteria "subject to no Event of Default having occurred which is continuing". After the Reinvestment Period, however, all Scheduled Principal Payments are to be paid to noteholders in accordance with the waterfall provisions of the CLO.

Clause 11.5 deals with the application of UPP. It will be recalled that these represent early repayment of debt. That clause provides that during the Reinvestment Period and the third relevant period the Collateral Manager will apply UPP as follows in the acquisition of further Collateral Obligations satisfying the Reinvestment Criteria:

“11.5

Unscheduled Principal Proceeds

(a)

During the Reinvestment Period and up to and including the Payment Date in October 2015, the Collateral Manager (acting on behalf of the Issuer) shall use all commercially reasonable efforts to apply the Unscheduled Principal Proceeds received in the related Payment Period with respect to any Collateral Obligation which are not required to be used to repay any VF Advance pursuant to Condition 19(d) (Repayment of VF Advances) in the acquisition of further Collateral Obligations satisfying the Reinvestment Criteria, subject to:

(i)

no Event of Default having occurred which is continuing; and

(ii)

the Collateral Manager certifying to the Trustee that in its professional opinion such Unscheduled Principal Proceeds can be reinvested in further Collateral Obligations which it has identified in compliance with the Reinvestment Criteria.

(b)

After the Payment Date in October 2015, all Unscheduled Principal Proceeds received with respect of any Collateral Obligation which are not required to be used to repay any VF Advance pursuant to Condition 19(d) (Repayment of VF Advances) shall (unless required to be reinvested in Eligible Investments as provided for in the terms and conditions of the Notes) be deposited in the Principal Account, as applicable and disbursed in accordance with the Priorities of Payment on the first Payment Date following receipt thereof.”

It is common ground that no Event of Default has occurred or is continuing. It is also common ground that UPP are being received which are not required to be used to repay any VF Advance and must therefore be reinvested if the Reinvestment Criteria are satisfied. Clause 11.7 of the CMA requires reinvestment of UPP within three Payment Periods after receipt. If they are not so reinvested, the UPP will be applied in redemption of the Notes in accordance with the waterfall provisions of the CLO.

The Eligibility Criteria, which must be met at the date of acquisition of each Collateral Obligation, are set out in the first part of Schedule 2 to the CMA. The two relevant criteria for present purposes are:

“32 in respect of each Collateral Obligation which is a sub-participation, the relevant Underlying Loan … is rated at least “A” by Fitch…”

“41 each Collateral Obligation has a Fitch Rating of at least “B-” …”

The Reinvestment Criteria are set out in paragraphs 1 to 8 of schedule 2 to the CMA under the heading "Reinvestment Criteria". Paragraphs 1 to 4 of the definition of Reinvestment Criteria, which are the relevant criteria, read as follows:

“Reinvestment Criteria

The Reinvestment Criteria are as follows:

(1)

such further Collateral Obligation is a Collateral Obligation which satisfies each of the Eligibility Criteria;

(2)

during the Reinvestment Period only, either (i) the Coverage Tests are satisfied after giving effect to such purchase or (ii) if immediately prior to such purchase any Coverage Test was not satisfied, the related value is maintained or improved after giving effect to such purchase provided that, notwithstanding this paragraph, the Coverage Tests must be satisfied upon any reinvestment of Scheduled Principal Proceeds and of Sale Proceeds from Defaulted Collateral Obligations during the Reinvestment Period;

(3)

after the Effective Date and during the Reinvestment Period only, either (i) after giving effect to such purchase, the Collateral Obligations in aggregate satisfy the requirements of the Portfolio Profile Tests or (ii) if any such requirement is not satisfied prior to such purchase, such requirement will be maintained or improved after giving effect to such purchase;

(4)

after the Reinvestment Period and until the Payment Date in October 2015 only, in the case of the reinvestment of Unscheduled Principal Proceeds, (i) the ratings of the Class A1 Notes have not been downgraded below their Initial Ratings, (ii) all the requirements of Portfolio Profile Tests shall be satisfied both prior to and after giving effect to such purchase, (iii) all the Coverage Tests shall be satisfied both prior to and after giving effect to such purchase; (iv) the expected maturity of the additional Collateral Obligation is not beyond the expected maturity of the Collateral Obligation which was the source of such Unscheduled Principal Proceeds and (v) the Scenario Default Rate for the Proposed Portfolio is equal to or lower than the Scenario Default Rate for the Current Portfolio or where the Scenario Default Rate for the Proposed Portfolio is higher than the Scenario Default Rate for the Current Portfolio, a Rating Agency Affirmation has been received from S&P.”

Criterion 4 (i) (italicised) is the critical provision.

As mentioned above the Senior Notes were downgraded on 5 February 2010 by S&P from their Initial Rating of AAA to a rating of AA, although they were then upgraded back to an AAA rating by S&P on 30 November 2012.

Between 8 October 2013 and 8 January 2014 UPP amounting to €7,638,657.45 were received. Those UPP were not reinvested on the Payment Date which occurred on 15 January 2014 because, among other things (viz. non-satisfaction of other conditions), the Collateral Administrator decided that the Reinvestment Criteria were not met in view of the rating downgrade which had occurred between 5 February 2010 and 30 November 2012. In other words, the Collateral Administrator was of the view that criterion 4(i) was not and never could be satisfied. The UPP were used towards redemption of the Notes. Further UPP amounting to €11,758,108 were received between 8 January 2014 and 21 February 2014. It is reasonable to think that there will be further substantial UPP receipts before the Payment Date in October 2015.

Napier Park says that, if the UPP are reinvested, that would benefit the Junior Noteholders. If, on the other hand, the UPP are applied towards the redemption of the Notes in accordance with the waterfall provisions of the CLO, the Junior Noteholders will not receive any benefit. In the current financial circumstances it is in the interest of the Senior Noteholders that the Senior Notes be redeemed early so that they can invest in new notes with a similar AAA rating but which will, in view of changes in the market since 2006, pay a greater margin than the EURIBOR + 0.2% paid by the Issuer on the Senior Notes. Had interest rates moved in the opposite direction it might not have been.

At [37] and [38] the Chancellor set out the applicable principles of interpretation:

“[37] … For the purposes of the present proceedings, the following points are of particular relevance. Firstly, the overriding objective of the interpretation of a contract is to ascertain the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract (excluding, for policy reasons, prior negotiations and declarations of subjective intent). Secondly, in carrying out that exercise the starting point is always the ordinary, natural and grammatical sense of the language used by the parties in its context because the assumption is that people usually intend the words they use to have their natural and ordinary meaning. The context includes the document and the transaction as a whole. Where it is clear from the context that the parties have adopted a specialist vocabulary, the starting point is the natural and ordinary technical meaning of the specialist terms. Thirdly, in cases where in its context the language used is ambiguous, in the sense that it is capable of bearing more than one meaning, that interpretation is to be preferred which is most consistent with business common sense, that is to say most consistent with the commercial purpose of the transaction. Fourthly, where it is clear both that a mistake has been made in the language used and what a reasonable person would have understood the parties to have meant, the contractual provision must be interpreted in accordance with that meaning. Fifthly, if the words in their context are unambiguous and it cannot be said that something must have gone wrong with the language, then, subject to a successful claim to rectification, the court must apply that unambiguous meaning even though some other language or meaning would be more commercial. The fact that it would produce a poor bargain for one of the parties is not sufficient to adopt another meaning. The objective of interpretation is to interpret the contract and not to re-write it in the light of hindsight and the judge's, let alone one party's, own notion of what would have been a reasonable solution if the parties, as reasonable people, had ever thought about it.

[38] The principles for the interpretation of a contract are the same whether the document relates to a single commercial venture, in which the contracting parties will remain the same throughout, or the document is intended to confer rights and obligations which it is contemplated may pass to persons other than the original contracting parties, such as title documents to property or, as in the present case, tradable financial instruments. In the case of the second category, however, it is reasonable to assume that the parties will have been particularly conscious of the need for clarity and certainty in the language they have used. It is for that reason that the court should be particularly cautious about departing from the ordinary and natural meaning of the words in documents of that kind.”

Applying these principles, the Chancellor concluded that the language of criterion 4 (i) was unambiguous. He began with the ordinary meaning of the phrase. At [42] he said that:

“The words used are the present perfect indicating that something has happened at an unspecified time in the past.”

He went on to examine closely the way in which the drafter of the documents had used different tenses in relation to different provisions and decided that this sophistication provided support for his view that the ordinary meaning of criterion 4 (i) was that it was referring to a past event and not to a continuing state of affairs. His essential reasoning was as follows:

“[43] The documentation as a whole provides strong support for that interpretation. The drafting of the CMA and of the conditions to the Notes makes clear when it is material that a particular state of affairs must continue in order to have a specified effect. Clauses 11.1, 11.2, 11.3, 11.4, 11.5 and 11.6 of the CMA all specify as a pre-condition of reinvestment that "no Event of Default [has] occurred which is continuing". Specifically in relation to the possibility of a downgrading of the Initial Ratings of the Notes, clause 10.5 of the CMA provides what is to happen to amounts standing to the credit of the Unused Proceeds Account "[i]f on the Effective Date no Effective Date Rating Event has occurred and so long as an Effective Date Rating Event is not continuing". Condition 3(c)(GG) of the Notes stipulates that the Principal Proceeds must be applied in redemption of the Notes "in the event of the occurrence of an Effective Date Rating Event which is continuing on the second Business Day prior to the [relevant] Payment Date …. until the Rating Agencies confirm the Initial Ratings of the Notes". Similar language is used in condition 7(d) of the Notes. By contrast with Paragraph 4(i) all those expressions make clear and deliberate allowance for a material change of circumstances, including an upgrading of the ratings of the Notes following a downgrading.

[44] The drafter has also made a conscious selection of different tenses – past, present and future – within each of the sub-paragraphs of the definition of the Reinvestment Criteria in schedule 2 to the CMA. All those tenses have been used in different parts of Paragraph 4(i) itself.

[45] Even in relation to the specific instance of a downgrading of the Notes, the drafter has elsewhere used language to indicate a current downgrade, as in the expression "the Initial Ratings of the Notes being downgraded" in the definition of Effective Date Rating Event in the Notes.”

He concluded at [58]:

“I therefore consider that Paragraph 4(i) is clear and unambiguous. It is not satisfied if the Senior Notes have at any time been downgraded below their Initial Ratings. In view of the downgrade by S&P in February 2010 it is now incapable of being satisfied.”

Mr Miles submits that it is important for the interpreter not to be beguiled by his or her initial impression or to limit the process of interpretation to purely linguistic points, but to delve deeper into the landscape of the transaction as a whole. He submits that if that exercise is undertaken, it can be seen that the words “the ratings of the Class A1 Notes have not been downgraded below their Initial Ratings” apply only to a case in which the downgrade continues in force as at the date of the potential reinvestment. Mr Miles argues that the approach that the Chancellor adopted involved an unduly narrow, grammatical reading of the ratings test, which failed to take account of its obvious purpose and the context in which the words were used. The iterative approach to the interpretation of contracts required possible rival interpretations to be tested, not only against other textual indications in the contract, but also the commercial consequences of each competing interpretation. It was not right to divorce a consideration of the commercial consequences from textual analysis and to treat it as a bolt on or cross-check.

He says that the Chancellor’s approach also ignored the fact that language here, as so often, is capable of different meanings depending on the way it is used. A test or question expressed in the past tense is capable of referring to the historical past, the immediate past or, indeed, the present position. The relevant frame of reference depends on the context and purpose for which the question is asked. This argument led to the conclusion that the Chancellor was wrong in holding that the words were clear and unambiguous, in the sense that the meaning that he adopted was the only possible meaning.

Once an alternative reading emerges as a possible meaning, the interpreter must go on to consider which of two or more possible meanings is the more commercially sensible. The Chancellor did not do that, because he stopped at the first stage; namely by deciding that the language was clear and unambiguous. If the Chancellor had proceeded to the second stage, he should have preferred the interpretation that the downgrade had to be in force at the time when the Reinvestment Criteria had to be satisfied.

If one starts with the grammatical form of the disputed phrase it is what grammarians would call a combination of the present tense and the perfect aspect. In the disputed phrase it is also expressed in the passive voice. This grammatical construction can be, and often is, used to describe something that started in the past and continues in the present, or to describe something that happened in the past but whose effect is felt at the present. Where the phrase is in the passive voice, ordinary English requires the use of the past participle of the verb and a form of the auxiliary verb “to be”. So if one says of a couple that “they have been married for twenty years” one is necessarily also saying that they are still married. If a householder asks the window cleaner “have the windows been cleaned?” what he means is: are they now clean? It is not an answer to the question properly understood for the window cleaner to say “yes” if they were only cleaned several years ago. In both these examples the past participle of the verb is combined with the past form of the auxiliary, but the meaning clearly refers to the present state of affairs. The Chancellor was thus wrong to treat the past tense as of itself connoting reference to a historical downgrade of the Class A1 Notes at any previous time.

The next point is that, as is common ground, the Reinvestment Criteria have to be applied at the time when the reinvestment is made. This follows from the definition of Collateral Obligation. If that definition is combined with the relevant Reinvestment Criterion the combined effect is that “at the date of the proposed reinvestment the ratings of the Class A1 Notes have not been downgraded below their Initial Ratings”. On its natural and ordinary meaning, this phrase requires a comparison of the current rating with the Initial Ratings. It does not call for an investigation into whether the ratings may at some point in the past have been below the Initial Ratings if they are no longer below that rating. The vantage point from which this question is asked is the date of the reinvestment. From that perspective it is a perfectly sensible answer to the question “have the notes been downgraded” to say “no they have not”, even if for the sake of completeness one might add that they had been downgraded at some time in the past, but had subsequently been upgraded to their original status.

This interpretation is supported by a consideration of the nature of a credit rating as a forward looking view of the credit quality of a Note. It is the latest, current, rating which matters because a note rated at AAA now is of the same credit quality as when that note was rated AAA earlier in its life. An AAA rating amounts to the rating agency saying that it is as sure as it can be that the creditor will be repaid in full and on time. This interpretation is also supported by a consideration of the overall structure of the transaction, and the purpose of criterion 4 (i). That purpose was that if the Senior Noteholders were at risk at the date of any proposed reinvestment, then the monies in question should go towards redemption of their Notes. But if they were not at risk (and if the Notes were rated AAA Mr Miles said that they would not be) then the monies should be available for reinvestment.

None of the Senior Noteholders appeared either before the Chancellor or on the appeal. Mr Snowden QC, appearing for the Trustee, who advanced the arguments that the Senior Noteholders could have advanced, supported the Chancellor’s interpretation. He said that the Chancellor had carried out an impeccable exercise in interpretation, starting with the natural meaning of the words, checking that meaning against the remainder of the documentation and correctly arrived at the conclusion that their meaning was clear and unambiguous. Having reached that conclusion there was no need for him to consider the rival commercial considerations of the competing interpretations. The suite of documents in this case has no purpose except to create the structure that the words themselves create. But to the extent that it was relevant the interpretation that he preferred did make commercial sense. The starting point for considering the commercial considerations was the significance of the downgrade of the rating of the Notes. It was almost unheard of for grade AAA notes to be downgraded. The very fact that they had been downgraded showed that the Collateral Manager had not been able to manage the Portfolio so as to maintain that all-important rating. That of itself exposed the Senior Noteholders to risk; and in those circumstances it was entirely rational for them to insist on being paid as soon as possible after the end of the Reinvestment Period. The end of the Reinvestment Period marked a significant change in the structure of the investment. Once that period had come to an end then in principle all Principal Proceeds must be used in redemption of the Notes in accordance with the waterfall. The possibility of reinvesting UPP is a limited carve-out from that regime. The combination of that and the historic downgrade of the Class A1 Notes is truly a game-changer.

The approach to the interpretation of a tradable financial instrument of this kind was authoritatively considered by the Supreme Court in Re Sigma Finance Corp [2009] UKSC 2; [2010] 1 All ER 571. In that case Lord Mance, approving Lord Neuberger’s dissenting judgment in the Court of Appeal, said at [12]:

“Lord Neuberger was right to observe that the resolution of an issue of interpretation in a case like the present is an iterative process, involving “checking each of the rival meanings against other provisions of the document and investigating its commercial consequences”.”

The iterative process thus described is not confined to textual analysis and comparison. It extends also to placing the rival interpretations within their commercial setting and investigating (or at any rate evaluating) their commercial consequences. That is not to say that in a case like this the commercial setting should be derived from considerations outside the four corners of the contractual documents. As Lord Collins said in the same case at [37]:

“Consequently this is not the type of case where the background or matrix of fact is or ought to be relevant, except in the most generalised way. … Where a security document secures a number of creditors who have advanced funds over a long period it would be quite wrong to take account of circumstances which are not known to all of them. In this type of case it is the wording of the instrument which is paramount. The instrument must be interpreted as a whole in the light of the commercial intention which may be inferred from the face of the instrument and from the nature of the debtor's business. Detailed semantic analysis must give way to business common sense…”

Thus we must seek to discern the commercial intention, and the commercial consequences from the terms of the contract itself; and that feeds in to the process of deciding whether a particular word or phrase is in reality clear and unambiguous. It follows in my judgment that, where possible, the court should test any interpretation against the commercial consequences. That is part of the iterative exercise of interpretation. It is not merely a safety valve in cases of absurdity. So much is, in my judgment, also made clear by the decision of the Supreme Court in Rainy Sky SA v Kookmin Bank [2011] UKSC 50; [2011] 1 WLR 2900. In that case Lord Clarke said at [20]:

“It is not in my judgment necessary to conclude that, unless the most natural meaning of the words produces a result so extreme that it was unintended, the court must give effect to that meaning.”

Lord Clarke went on to approve the observation of Longmore LJ in Barclays Bank plc v HHY Luxembourg SARL [2010] EWCA Civ 1248; [2011] 1 BCLC 336:

“25.

The matter does not of course rest there because when alternative constructions are available one has to consider which is the more commercially sensible. On this aspect of the matter Mr Zacaroli has all the cards. ...

26.

The judge said that it did not flout common sense to say that the clause provided for a very limited level of release, but that, with respect, is not quite the way to look at the matter. If a clause is capable of two meanings, as on any view this clause is, it is quite possible that neither meaning will flout common sense. In such circumstances, it is much more appropriate to adopt the more, rather than the less, commercial construction.”

Lord Clarke continued:

“In my opinion Longmore LJ has there neatly summarised the correct approach to the problem. That approach is now supported by a significant body of authority. As stated in a little more detail in para 21 above, it is in essence that, where a term of a contract is open to more than one interpretation, it is generally appropriate to adopt the interpretation which is most consistent with business common sense.”

I do not therefore agree with Mr Snowden that commercial considerations have no part to play in deciding whether a particular interpretation is or is not ambiguous. Moreover, to say that ambiguity or unambiguity is the governing factor may be to miss the point. As Lord Sumption observed in Sans Souci Ltd v VRL Services Ltd [2012] UKPC 6 at [14]:

“It is generally unhelpful to look for an “ambiguity”, if by that is meant an expression capable of more than one meaning simply as a matter of language. True linguistic ambiguities are comparatively rare. The real issue is whether the meaning of the language is open to question. There are many reasons why it may be open to question, which are not limited to cases of ambiguity.”

On the other hand where the iterative process of interpretation as described above produces a clear answer a court must be very wary of assuming that it knows what is or is not commercially sensible: Skanska Rashleigh Weatherfoil Ltd v Somerfield Stores Ltd [2006] EWCA Civ 1732 at [22].

Both sides, while disavowing the argument “if that is what the phrase means why did the draftsman not say it?”, pointed to different forms of words which would have put the other side’s interpretation beyond doubt. Mr Miles said that Mr Snowden’s interpretation was tantamount to reading the criterion as if it said that “the ratings of the Class A1 Notes have never been downgraded below their Initial Ratings”; and for good measure added that if the only question was whether they had ever been downgraded then the phrase “below their Initial Ratings” was redundant. Mr Snowden, for his part, said that Mr Miles’ interpretation was tantamount to reading the criterion as if it said “the ratings of the Class A1 Notes are not below their Initial Ratings” and that this gave no effect to “have not been downgraded”. I did not find that exercise helpful.

In the present case I agree with Mr Miles that the language of criterion 4 (i) is open to question. Even viewed simply as a matter of grammar the disputed phrase is capable in normal English usage of referring to something which is continuing or something which has continuing effect; and its grammatical construction often is used in that sense. The Chancellor correctly said that the tense (or tense and aspect) was the present perfect, but simply as a matter of grammar I consider that he took too narrow a view of the possible usages of that construction. The point at which the question falls to be answered gives support to that conclusion. I do not therefore agree with the Chancellor that in ordinary usage the phrase can only refer to a past historic event at some indefinite point. My starting point thus differs from his.

I readily acknowledge, as the Chancellor pointed out, that there are textual differences in various parts of the documents; notably in the reiteration of the phrase “and is not continuing” in relation to Events of Default. Mr Miles submitted that that phrase was used in relation to things which had happened (such as Events of Default) whereas criterion 4 (i) was concerned with things that had not happened. However, clause 11.5 speaks of “no Event of Default having occurred which is continuing”, which is a negative, so I do not think that this point is a good one. What is a better point, to my mind, is that to some extent whether such a phrase is necessary to make the meaning of criterion 4 (i) clear depends on whether you think that a historic downgrade of the Class A1 Notes may be a relevant factor at all. There are also other linguistic pointers in favour of the interpretation that the Chancellor preferred. For example paragraphs 32 and 41 of the Eligibility Criteria under the CMA use the present tense in assessing ratings. Paragraph 4 of the Reinvestment Criteria itself uses a variety of different tenses to express temporality. But some of these require a certain amount of reading in. Thus criterion 4 (ii) provides:

“all the requirements of Portfolio Profile Tests shall be satisfied both prior to and after giving effect to such purchase”

Here “shall be” is used in the sense of “must be”. It is not looking to the future. It is looking to the present. Temporality is conveyed by “prior to and after”. But even here the criterion must mean “immediately prior to and immediately after”. Whether the criterion is satisfied is determined, as Mr Miles showed us, by the Collateral Administrator consulting a database which it was required to compile and giving the answer within one business day. The same is true of criterion 4 (iii).

Both sides agreed that the contrast that the Chancellor drew at [45] between criterion 4 (i) and the definition of Effective Date Rating Event was an error on his part. Read as a whole the definition is referring to an event (namely a downgrade) following a request by the Collateral Administrator. It is not, as the Chancellor thought, referring to a state of affairs. That does to some extent weaken the reliance that one can place on the different verb forms that the drafter has used.

It is particularly important at this point to consider the overall structure of the transaction. We have seen that in dealing with an Effective Date Rating Event the parties did not treat a downgrade of the initial ratings as an irreversible event with continuing consequences. On the contrary, if the Collateral Manager put forward a Rating Confirmation Plan for the reinstatement of the rating, which the Rating Agency accepted, then no Effective Date Rating Event would occur at all. As Mr Miles put it, in that event the slate was wiped clean. Yet the downgrade would have been a historic fact which took place in or about May 2007. If the parties agreed that a downgrade followed by a reinstatement of the rating of the Notes at the outset of the investment programme would have no consequences for the acquisition and management of the portfolio, why should they be taken to have agreed that that historical event springs into life many years later in October 2013? Moreover, even if an Effective Date Rating Event does occur, its effects under condition 7 (d) only last until the rating is restored. Here again we see the parties agreeing that a downgrade followed by an upgrade does not have continuing consequences.

The next point to make is that during the Reinvestment Period a downgrade of the Notes has no contractual effect. Reinvestment of all Principal Proceeds (including both Scheduled Principal Proceeds and UPP) proceeds as though the downgrade had never happened.

Third, the Reinvestment Criteria with which we are concerned apply only to UPP, that is to say to monies that were unanticipated. All Scheduled Principal Proceeds (that is to say monies that were expected to be received) are to be applied in redeeming the Notes in accordance with the waterfall. It follows that if no UPP are received but borrowers simply repay in accordance with the underlying obligations of the Collateral Obligations, the Senior Noteholders have no right to complain that redemption of their Notes derives entirely from Scheduled Principal Proceeds; nor that Junior Noteholders continue to receive interest payments on Collateral Obligations under which the borrowers choose not to redeem early. The receipt of UPP does not depend on any action by any of the parties to the CLO. It is entirely at the discretion of third parties. If at the date when the UPP arise the Rating Agencies are as sure as they can be that the Senior Noteholders will be paid in full and on time (which is what an AAA rating means), why should reinvestment of the UPP be absolutely prohibited because of an event that might have taken place years ago, and in circumstances in which the parties had agreed that the slate should be wiped clean?

Fourth, the obligation to reinvest UPP contained in clause 11.5 applies “[d]uring the Reinvestment Period and up to and including the Payment Date in October 2015.” The obligation itself is a unitary obligation. That does not support the notion that a sea-change takes place at the end of the Reinvestment Period. Clause 11.6 by contrast deals with the two different periods in two separate sub-clauses. Moreover, the obligation to reinvest is precisely that: an obligation. It does not confer a right on the Senior Noteholders, nor a discretion on the Collateral Manager.

I do not think that Mr Snowden had any real answer to these points. I do not agree with Mr Snowden that the end of the Reinvestment Period marks a sea-change in the nature of the obligation to reinvest or that any compelling purpose can be ascribed to a provision whose consequence is that a downgrade followed by an upgrade in 2007 which had no immediate contractual consequences at all springs into life some six years later. In the absence of any evidence to that effect I am unable to accept the submission that a Note with a current AAA rating which it has not always enjoyed is viewed in the market as a worse risk than a Note which has always had that rating (AA?A as opposed to AAA), which is the other foundation of Mr Snowden’s suggested rationale. Nor with the utmost respect to him do I agree with the Chancellor’s analysis of the structure of the transaction and the effects of the rival interpretations.

To paraphrase Lord Mance in Sigma Finance, the interpretation for which Mr Snowden contends raises the effect of a historic downgrade of the Class A1 Notes “to a level of pre-dominance which it was not designed to have in a context where, if given that level of pre-dominance, it conflicts with the basic scheme” of the CLO.

For these reasons I would allow the appeal.

I agree.

I also agree.