Law Debenture Trust Corporation Plc v Acciona SA & Ors

This is an application by the Claimant by Part 8 claim form issued on 10^th February 2004 seeking directions as to the construction of a provision in a Trust Deed as set out in this judgment as between the Claimant as Trustee and the Defendants as Beneficiaries.

The issue with the construction concerns the meaning of the expression contained in Condition 12 ‘materially prejudicial to the interests of the Bondholders" in the context of a Bond Issue where the Claimant is the Trustee of the Bond Issue and the Defendant Beneficiaries are Bondholders.

The wording referred to above appears in Condition 12 of the Second Schedule to the Amended and Restated Trust Deed dated 15^th November 2002 (‘The Trust Deed’) between Elektrim Finance BV (‘The Issuer’), Elektrim S.A. (‘The Guarantor’) and the Claimant, the Law Debenture Trust Corporation Plc (‘The Trustee’).

The subject of the Trust Deed comprises 510 million Euro 2% Bonds ("the Bonds") due 2005 of the Issuer.

Condition 12 sets out the Events of Default upon the occurrence of which the Trustee is entitled or may become bound to give a notice to the Issuer and the Guarantor that the Bonds have become immediately due and repayable, together with accrued interest.

The two major provisions about which the arguments essentially revolved were Condition 10(d) and 12(ii), which provide as follows:-

I refer to the witness statement of Mr Roome dated 10^th February 2004, a partner in the firm of Bingham McCutchen LLP (‘BMC’), solicitors to the Defendants, which sets out the factual background. The Trustee’s application was supported by a witness statement signed by John Davies, a partner in the firm of Simmons & Simmons, also dated 10^th February 2004 but nothing factually significant is set out in that witness statement for self evident reasons beyond the rehearsal of the arguments justifying its present application as set out in paragraph 10 thereof.

Reverting to Mr Roome’s witness statement, as I have said it sets out the Defendants are beneficiaries under the Trust Deed and holders of over 30% face value of the Bonds (as defined above), issued by Elektrim Finance guaranteed by Elektrim.

Elektrim is the parent company of a substantial Polish Group with its registered office at YL.Panska, 77/79, 00-834 Warsaw. Its principal asset is and has been its 49% shareholding in and loans to a telecommunications company, Elektrim Telecommunikacja Sp.z.oo (‘ET’). Elektrim also owns 49% of Carcom Warsaw Sp.Z.oo (‘Carcom’). ET and Carcom together directly or indirectly own 51% of Poland’s largest mobile phone company Polska Telefonia Cyfrowa Sp.Zo.o. (‘PTC’).

In July 1999 Elektrim Finance issued and Elektrim guaranteed 440 million Euro’s 3.75% Euro linked exchangeable bonds due 2004. These bonds are and have been held and traded by Bondholders including the Defendants.

The Bondholders’ interest under the Bonds are clearly to ensure that payments due under the bonds (including annual interest payments and following the restructuring and as set out further in this judgment mandatory redemption payments and contingent payments) are made in full on time and that the Bonds are ultimately redeemed in full. In addition, they plainly have an interest in ensuring all other rights and benefits which are exercisable for the benefit of the Bondholders, ancillary to the bonds and to provide security or protection for the bonds remain fully in place and enforceable. That seems to me to be self-evident.

The original bonds were redeemable on 17^th December 2003. The Bondholders were originally granted an optional redemption exercisable on 15^th December 2001. Commencing in May 2001 certain Bondholders commenced discussions with Elektrim to ensure it had taken the necessary steps to fund the redemption, which was expected to be exercised by the great majority of the Bondholders. Substantial funds sufficient to fund the redemption were received by Elektrim during August of 2001. By early December 2001 it had become clear to the Bondholders that those funds had been applied in payments to other creditors in preference to the Bondholders and that both Elektrim and Elektrim Finance would default on their respective obligations upon the exercise of the optional redemption.

Accordingly, almost all Bondholders exercised their redemption option on 17^th December 2001. During a seven-day grace period following that, limited negotiations took place but no agreement was reached with the result that on 24^th December 2001, both Elektrim Finance and Elektrim defaulted on the Bonds in the sum of Euro 479,332,722 (‘the December Default’).

On 28^th December 2001, Elektrim filed an application for composition in the Warsaw District Court (this is a procedure somewhat akin to an administration order in England and Wales). The Trustee issued a cross application on behalf of the Bondholders for bankruptcy but that was dismissed on 16^th January 2002 and the composition application was accepted by the Polish Court instead.

Following the December default and the commencement of the Composition Proceedings, negotiations ensued between the Bondholders through a negotiating committee and Elektrim. Those negotiations lasted from January 2002 until September 2002.

Towards the end of that period on 13 September 2002 Elektrim filed for bankruptcy. The market value of the Bonds fell significantly as a result. In the period leading up to the hearing of Elektrim’s bankruptcy proceedings, intensive negotiations took place between the Bondholders and Elektrim to see if it might be possible to agree alternative restructuring terms and avoid a bankruptcy.

It was obvious to the Bondholders that a cash payment would not be available to them in the near future. The Bondholders were therefore anxious to obtain the maximum security for their lending under the Bonds and ensure that monies, which became available to Elektrim in the future, would be properly applied to making payment under the Bonds and to other creditors of the company. To this end, they sought and obtained in these negotiations (the relevant Condition 10(d) not being in the original Bonds) a power to appoint a member to Elektrim’s management board (‘the Bondholder Nominated Director’).

In respect of all transactions exceeding 25,000 Euro (a relatively modest sum in the circumstances), his consent was required. It followed, therefore, that the Bondholder Nominated Director (being one of three on the Board) provided considerable protection to the Bondholders. Any decision above the value referred to above required his consent. He was therefore in a position to block any transaction. There were no provisions under Condition 10(d) for his removal by the Board of Elektrim save in circumstances that either two Board members were removed or the whole Board was removed. Nor is it possible under the terms of Condition 10(d) to remove the Bondholder Nominated Director and then make decisions, which are supposed to be effective after his removal.

In other words at Elektrim Board level, complete unanimity was required and the Bondholders had a full right to participate in the decision-making processes of Elektrim at all times. This seems to me to be a very valuable right and was clearly so perceived by the Bondholders when they negotiated its introduction for the first time when the new terms in the Second Supplemental Trust Deed were finalised on or about 3^rd October 2002. I discern this from paragraph 8 of Mr Roome’s witness statement.

This evidence to me seems to be relevant material to be considered when construing the words of the Trust Deed as per Lord Hoffman in ICS v West Bromwich Building Society [1998] 1 WLR 896 at 912-913.

The Trust Deed is to be construed in accordance with English Law.

In view of the Bondholder’s lack of confidence in the company, the provision of security by granting to the Bondholders security over its own assets was also of utmost significance and they were given security in accordance with Clause 8. I do not propose to set out those provisions, as the actual wording is not of significance.

The Bonds were restructured on 15^th November 2002 in accordance with the new terms following approval thereof by a majority of Bondholders. At about the same time in accordance with the Bonds, Mr Piotr Rymaszewski (‘Mr Rymaszewski’) was appointed Bondholder Nominated Director. At that time Ryszard Opara and Wojciech Janczyk were acting as Directors of Elektrim nominated by it.

The Bondholders allege that Elektrim took a series of steps in breach of its obligations under the Trust Deed and the Bonds. The Trustee do not disagree that the acts complained of were all breaches of the Trust Deed.

The breaches are summarised in paragraph 14.2 of Mr Roome’s witness statement. Two of them are to my mind not particularly significant at this stage, namely failing to comply with the request for information (in breach of Clause 5.1 of the Trust Deed) (Item 4) and failing to pay the Trustee’s fees in breach of Clause 16 of the Trust Deed (Item 5). That is not to say that they are not significant but in the overall context of the matters before me, I do not see that they carry the weight that the other matters do.

The most important breach was the suspension of Mr Rymaszewski as Bondholder Nominated Director. This is a clear and substantial breach of Condition 10(d). There is no power to suspend the Bondholder Nominated Director. Subsequent to the suspension, various transactions have taken place involving loans and pledging of shares. Further transactions are also proposed. The Bondholders are totally excluded from the management of Elektrim and in particular in considering whether or not these transactions should take place. Quite apart from their inability to discuss them at Board level, they are deprived of an opportunity if necessary of blocking any transaction if they think it is appropriate so to do.

Elektrim has suggested (by its letter 17^th June 2003 to the Trustee) that the Bondholders could nominate an alternative Bondholder Nominated Director. The Bondholders informed the Trustee there could be no appointed replacement until Mr Rymaszewski had been properly dismissed in accordance with the procedures set out in Condition 10(d). The Trustee agrees with that analysis. So do I.

Requests had been made by the Bondholders of Elektrim to "unsuspend" Mr Rymaszewski and properly dismiss him, thereby permitting them to nominate a new director, but no such action has occurred. Elektrim seems determined to operate with the Bondholders totally excluded.

On 24^th July 2003 the Trustee gave notice to Elektrim that the suspension gave rise to a breach of covenant at Condition 10(d) and stated pursuant to Condition 12(ii) it required the breach to be remedied within 30 days. Elektrim failed to remedy the breach and failed to reinstate Mr Rymaszewski within 30 days or at all.

This is a serious material breach of the conditions of the Trust Deed. The Trustee accepts that as being the case.

The Bondholders’ case as summarised in paragraph 15.8 of Mr Roome’s witness statement is that the breach of covenant at Condition 10(d) fundamentally undermines the protections negotiated with the Bondholders because of the particularly significant nature of the power of appointment to the board and the ability to block any transactions at board level of any significant amount.

The urgency of the present application arises out of the fact that Elektrim had started to dispose of certain of his assets, which are secured in favour of the Bondholders. Each of these transactions is a breach of the covenants contained in Condition 10(d) as they exceed Euro 25,000 in value and have not been approved by the Full Management Board due to the wrongful suspension of the Bondholder Nominated Director.

The Trustee concurs in that analysis, as I do.

As I have said, the attitude of the Trustee is summarised in paragraph 10 of Mr Davies’ witness statement. It has been advised by Leading Counsel that before declaring an Event of Default by virtue of the breaches, it needs to determine whether the event or breach in question has in fact caused material prejudice to the interests of Bondholders. The Trustee is further advised that material prejudice means prejudice to the Bondholders, which is damaging in the sense of being materially harmful to the economic interests of the Bondholders. It accepts that the Court could conclude as a matter of construction of the covenant that there would be a Bondholder Nominated Director that such covenant was an important one such as the Bondholders were materially prejudiced simply by a breach of that covenant but its belief is that having had discussions with Elektrim in financial terms it does not believe that the Bondholder’s position has actually been materially prejudiced by the proposed transactions.

It is no part of the hearing before me to evaluate the evidence as to whether or not that is a correct conclusion to take. Equally, Elektrim is not a party to the present proceedings. Mr Potts Q.C. submitted that the application was akin to a Beddoe application, but of course it is somewhat different. The purpose of the Beddoe application is to obtain an indemnity for an estate. The Trustee needs an indemnity and that will be provided by the Bondholders. However, there is a dispute between the Trustee and the Bondholders as to the consequences of the breach of Condition 10(d) in the light of the requirements in the proviso of Condition 12. That is the issue in effect, which I am asked to determine.

If I determine it in favour of the Bondholders, Mr Potts Q.C. has indicated on behalf of the Trustee that subject to the proper indemnities being in place, it will serve the requisite default notice and if necessary commence the requisite proceedings. At that stage of course, any such proceedings brought against Elektrim might raise the same issue as to whether or not the Trustee was entitled to serve the default notice. Any decision I make as to the construction of the Trust Deed does not bind it and it is possible that the meaning of the clause might be re-visited at later stage, if that arises.

The Trustee’s case is that in respect of a breach of Condition 10(d) which falls within Condition 12(ii) the breach of itself does not constitute an Event of Default. At first sight, this might seem curious. For example, the failure to pay the interest (even if subsequently paid) by one day is an automatic Event of Default under Condition 12(i). One might have thought that that was surprising when contrasted with the important provision (as put forward by Mr Roome) at Condition 10(d), which does not automatically constitute an Event of Default. As I have said, Condition 10(d) was inserted into the draft at a later stage but it was accommodated alongside any other breach of the terms and falls within Condition 12(ii) for its enforcement.

The proviso requires "[that] the Bond Trustee shall have certified that such event is materially prejudicial to the interests of the Bondholders". In the context of a request in writing by 30% of the Bondholders, the Trustee is obliged to issue an Event of Default provided all the other criteria are satisfied.

The Trustee’s case is that for there to be an Event of Default for breach of Condition 12(ii), it must be satisfied that the event:-

is prejudicial

There was much debate before me (in amplification of the skeleton arguments) as to the effect of the words materially prejudicial and interests of the Bondholders.

It must clearly be a present breach and the Trustee must be presently satisfied that there is a breach, before it issues a certificate, and before that certificate can be issued it must be satisfied that it is prejudicial to the interests of the Bondholders in a material way. I do not see how any other conclusion is possible on the wording "is materially prejudicial".

The case of the Defendants as set out in a skeleton argument of Ms Prevezer QC who with Mr Stephen Houseman appears for the Defendants involved a number of submissions at variance with the Trustee’s stance. Thus she submitted that the interests of the Bondholders covered a far wider range of matters than merely the Bondholders’ legal or contractual rights or the economic interest of the Bondholders. However, as this argument developed, it seemed to me that it was impossible for her to identify in any meaningful way what wider interests would be so covered. It seems to me to be plain that the interests of the Bondholders in the proviso are in the interests in the bond, that is to say the contractual entitlements under the bond to the payment of interest and the repayment of the capital on the redemption date. In addition it also extends in my opinion to any ancillary rights which the Bondholders have to protect the entitlement to payment of interest and redemption. Thus it would extend to the security rights and most significantly in my opinion it would extend to the right to appoint the Bond Nominated Director. This is especially so, given the significance of this appointment as referred to in Mr Roome’s witness statement.

The second significant argument which she raised contrary to that of the Trustee was that the words "material prejudice" might also extend to potential harm which is more than minimal or trivial. I do not see how that argument can be correct. The Trustee has to issue a certificate. That is not merely an administrative act. It is plain that a certificate contemplates there has been a present breach, and that that event is(not may be) materially prejudicial to the interests of the Bondholders. That in my judgment, is a requirement that there must be material prejudice to the interests of the Bondholders.

Miss Prevezer QC also submitted in her skeleton argument that any breach of Condition 10(d) was by definition materially prejudicial to the interest of the Bondholders and any breach that went unremedied would also be a breach.

Once again I do not see that this argument is sustainable. The Trustee has to be satisfied that there is a material prejudice to the interests of the Bondholders. It is to be observed that it dose not have to be satisfied that there is any material breach. If the breach is not material, it is still possible for it to be materially prejudicial to the interest of the Bondholders. Equally a material breach might not be materially prejudicial. It is necessary for the Trustee to look at the consequences of any given breach before it can issue a certificate. It can only issue a certificate when it is satisfied that the event is materially prejudicial to the interests of the Bondholders.

How would the Trustee be satisfied? In most cases it will involve an investigation as to the facts. Of course their decision will be an expression of an opinion based on their investigation of the facts. It will not be self evidently determinative being an opinion, but I do not see how the Trustee can issue a certificate that there has in its opinion been material prejudice to the interests of the Bondholders, unless it has the information which justifies that conclusion.

This is capable of being tested by an example, I put to Miss Prevezer QC in argument. If there was a desire on the part of the Bondholders to replace the existing Bondholder Nominated Director but Elektrim in breach of its obligations under Condition 10(d) was persistently refusing to accept the nominee, that would be a breach of Condition 10(d). However, given the importance to the Bondholders to have representation, that breach would not cause material prejudice to their interests as long as they continue to have an effective continuity of representation on the board. If the existing board nominee had died or become incapable, that would be another matter. However, that analysis shows that even in respect of some parts of Condition 10(d) it is not possible to say without investigation as to the facts that a breach of that part of the Clause will necessarily cause material prejudice to the interests of the Bondholders.

However, the obligation of the Trustee in my opinion, is relatively straightforward. It has to ascertain that there is a breach. It then has to ascertain the consequences of the breach. If the consequences of the breach are that the interests of the Bondholders (as set out above) are materially prejudiced then, and only then can it issue a certificate. In most cases that will require an examination of the circumstances. However, that examination might be short, it might be long, depending on the nature of the breach and the acts complained of. It will also be dependent on the nature of the obligation that is broken. Some obligations (for example the reasons for refusal to accept a newly nominated director under Condition 10(d)) might require factual investigation.

Deploying these arguments the Trustee submits that it cannot be required to issue a certificate in respect of a suspension of Mr Rymaszewski until it has investigated the circumstances including the consequences of the disposals by the Board and has concluded that the suspension has caused material prejudice to the interests of the Bondholders.

In my view in relation to a total repudiation of Condition 10(d) that is an unnecessary exercise. Given what Mr Roome says about the importance of the Clause, it seems to me that it is self evident that there is present prejudice of a material nature to the interests of the Bondholders. They have a present interest in participating in and if necessary vetoing any transaction. The mere act of exclusion of Mr Rymaszewski is a material breach prejudicial to their interests in my opinion. They have been excluded from the Board, and deprived of their veto rights.

Mr Potts QC submitted that of course there may be an exclusion but no action has been taken, so there is a material breach but no material prejudice. I do not accept that. Given the factual background, it was plainly of vital significance that the Bondholders would have this representation and blocking power at all times.

Thus Mr Potts QC’s argument overlooks the right of the Bondholders to veto transactions even if it might benefit Elektrim but harm them or even if it accrues benefits to them. Of course in any event, in the context of Elektrim it is difficult to see given the low level of 25,000 Euros how there would ever occur a situation where the Board would not be making decisions on a day to day basis in breach of Condition 10(d).

A serious breach i.e. the exclusion of Mr Rymaszewski in my opinion becomes an even more serious breach when decisions are taken without him (and thus the Bondholders) being consulted, and if necessary being given the opportunity to which they are entitled to veto the transactions. It is to my mind clear, that there has been material prejudice to the Bondholders’ interests. The economic interests and the rights ancillary to the economic interests of the bonds have been prejudiced. It is difficult to see a more clear case of prejudice.

It is likely that this will only apply to a total repudiation of Condition 10(d), I say that because during the course of argument Miss Prevezer QC was unable to identify any other provision which would have quite such a significant effect. I should not be taken as deciding, however, that the repudiation of Condition 10(d) is a unique situation. As I have said the exercise required of the Trustee is to evaluate on a breach by breach basis.

I was referred to authorities under Section 459 of the Companies Act 1985 and also to various definitions in the Oxford English Dictionary. Finally I was referred to other parts of the Trust Deed. To my mind none of these references assists me. I have in mind the Court of Appeal decision in The Football Association Premier League Limited and others v. Panini UK Limited [2002] EWCA CIV. 995 and in particular paragraph 39 where Mummery LJ said this:-

In my view that observation is equally applicable to the question of construction of what are the words "materially prejudicial to the interests of the Bondholders". As I have said in my opinion the purported suspension of Mr Rymaszewski, which is a total repudiation of this fundamental provision, is not only a material breach, it is also self-evidently materially prejudicial to the interests of the Bondholders. I do not see it requires an investigation as to the transactions that have taken place. Even if the transactions objectively examined conferred benefits on the Bondholders or did not affect their interests in economic terms that does not address the fundamental issue which is that they were entitled to be heard and block (if they thought appropriate) any transaction whether it was beneficial or not. That right has been taken away by the breach and is clearly materially prejudicial. They have lost these rights and continue to be deprived of the right to issue them.

Accordingly, I would answer the question by determining that the suspension of Mr Rymaszewski in breach of Condition 10(d) is a breach of Condition 12(ii) which is materially prejudicial to the interests of the Bondholders and that the Trustee can certify to that effect without the need for any further investigation.

I have made an Order in these terms.